Yesterday a friend of mine sent me a message about something that I’ve been meaning to write about for some time. The gist of the message was that there are minimal differences in expense ratios when they move a hundredth of a percentage. He’s right.
There are a few brokerages that seem to be in an “expense ratio war” for many popular ETFs (exchange traded funds). Vanguard had the lowest fees for many years. However, Schwab and Fidelity have lowered their fees a lot and can be just as competitive as Vanguard.
The average investor shouldn’t care if their expense ratio is 0.04% or 0.06%. If you do the math, on a million dollar portfolio in the future, the difference is likely to be under a thousand dollars. While that may sound like a lot, but by then that likely won’t even pay your cable bill. (I joke… kind of.)
Even if you go from 0.06% to 0.15% it isn’t a huge difference.
So why care about expense ratios at all? It really starts to matter when you give up 1% of compounding interest year after year. Even a half percent can be a big deal. When you stop and think about it, it makes sense right? Paying 1% of a $200,000 house is $2000. Paying 0.04% is paying $80. Paying 0.06% is paying $120. So going from $80 to $120 is costing you $40, not a big deal. You want to avoid going to $2000 though. That’s a big expense to pay every year.
I love low fees as much as the next guy, but there is the law of diminishing returns. It’s like trying to squeeze water from a stone.
Banks and Interest Rates
For years, I’ve seen a bank advertise that they were paying as much as 10x as much interest than the national average. (I can’t remember which bank it was, which tells you how effective this kind of advertising is on me.) The bank had a small graph that showed the national average bank paid 0.05% in interest. Then they showed they were paying 0.5% interest on their high-yield account.
Those might not have been the exact numbers, but it was close. Essentially if you had $10,000 in the bank account, you’d earn $50 of interest a year instead of $5. Don’t get me wrong, I’ll take $45 for free. However, I won’t spend my time switching banks. I typically keep around $5000 in a bank anyway, so the interest difference is closer to $25 a year.
You have to give the bank a lot of money before the “10x” more interest amounts to much more than one free dinner out each year.
The other detail that isn’t mentioned in the ad is that many banks have similar high-yield interest accounts. There might not even be the need to switch banks at all.
It’s great to be able to shop around for the best rates and lowest investment expenses. However, I don’t think people should waste their time trying to chase zero expenses or an interest rate that isn’t going to generate great returns.
P.S. I tried to do something a little different with this than usual with this article today. I started with free-form typing as fast as I could think and then cleaned it up a bit at the end. Ideally, I’d have polished this article for a few days with charts and links to real data. However, one thing that I’ve really liked about blogging is that it is more informal. I try to get 90% of the idea out there in 10% of the time.