ETFs and mutual funds have what is called an “expense ratio”. An expense ratio is the underlying cost of managing the fund that is a background cost to the investor. It goes unnoticed by most people because it simply negatively impacts the return of the fund.
Example: There are 2 funds that are designed to track the S&P 500: Fund A and Fund B. Fund A has an expense ratio of 1%, while Fund B has an expense ratio of 0.1%. If the S&P has a return of 10%, Fund A will have a return of 9%, while Fund B will have a return of 9.9%.
|Fund A||Fund B|
|S&P 500 Return||10%||10%|
|– Expense Ratio||1%||0.1%|
|= Net Return||9%||9.9%|
This may not seem like a big deal, but if this happens over a 30-year period to an initial investment of $10,000, Fund A turns into $132,677, while Fund B turns into $169,797. That’s a difference of $37,120!