I keep seeing a TV commercial in which Daniel Gilbert, a Harvard psychology professor helping to advertise Prudential mutual funds, asks a crowd of people how much money they have in their pocket. People mention small sums of cash and Gilbert asks, “Could it be that something that small can make an impact on something as big as your retirement?”
The prof then knocks over a tiny domino marked $45 that begins a chain reaction of falling dominoes, leading to one that is 30 feet tall crashing to the ground. “… if you let it grow for 20, 30 years, that retirement challenge might not seem so big after all.”
Trouble is that the fees charged by Prudential and many other mutual fund companies, particularly for those funds that are actively managed and/or have 12b-1 fees, could seriously retard that growth.
According to Morningstar, the average fee for Prudential domestic stock funds is 1.34 percent. This expense ratio is typical of the active fund universe. On the other hand, the Vanguard Total Stock Market Index Fund Admiral Shares has a management fee of 0.05 percent.
If you assume a tax-free investment of $20,000 in the Vanguard fund earning 7 percent for 30 years, you wind up with about $150,000. At the Prudential fee of 1.34 percent, the same initial investment with an equivalent return becomes a relatively measly $104,000 after three decades. (Note: the assumed return is an example for illustration purposes, not necessarily what an investor will receive.)
You can see this for yourself using any number of online calculators.
Something tells me that in real life some of those actively managed dominoes might not make it to the end zone.