Index funds and ETFs

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There is a way you can boost returns without taking on additional risk: stick to low-cost broadly diversified index funds and ETFs.

For example, a recent Morningstar fee study showed that the asset-weighted expense ratio for all actively managed mutual funds is roughly 0.80% compared with about 0.20% for index funds and ETFs. And you can even find many index funds with annual expenses of 0.10% or less. There’s no guarantee that every basis point you save in expenses will translate to a basis point of higher return, but funds with lower expenses do tend to outperform their high-expense counterparts.

And make no mistake that the extra return you’re likely to get by reducing investment costs can dramatically improve your retirement prospects. Remember how our hypothetical 35-year-old above would have to ratchet up his savings rate to almost 20% given lower projected returns? Well, if he managed to get his annual investment expenses down to 0.25% by sticking to low-fee index funds and ETFs, that annual savings burden would drop to a more doable 15% or so.

Ultimately, there’s not much you can do about the level of returns the financial markets deliver. So rather than falling for a pitch for some magical investment that purports to offer higher returns with no additional risk — or pumping up your stock holdings to try to boost returns — you’re better off focusing on the things over which you have at least some control: how much you save and spend, how you divvy up your savings between stocks and bonds and how much of your return you give up to investment expenses.

 

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