Source: The low cost of investment success Robin Bowerman | 12 September 2014
Investment researcher Morningstar has consistently found that low-cost share funds are most likely to succeed in the future.
By contrast, past performance is not an indication of future performance, as Smart Investing emphasised recently in The past performance trap.
In a recent research article, Lower your fees, boost your returns, Russel Kinnel, director of fund manager research with Mornngstar in the US, examined what he refers to as the "success rate" of broad-based US share funds over the five years from 2008.
Kinnel defines the success rate as the percentage of funds that "survived and outperformed" in their funds management category over a given period. (He is not referring to outperforming their indices.) "It's important to take into account funds that are liquidated because high-cost funds are more likely to be killed off than low-cost funds," he writes.
"Thus," Kinnel adds, "failures from high-cost groups are wiped away. If you don't account for those failures, your study is survivorship biased."
In his research, Kinnel ranked broad-based US share funds in June 2008 in accordance to their expense management ratio, ranking their expenses on a scale of one (being the lowest cost) to five.
Kinnel found that share funds in the lowest-cost quintile had a 55.98 per cent "success rate" over the period examined followed by the funds in the second lowest-cost group with a success rate of 45.69 per cent. Funds with average expenses had a 38.84 per cent success rate while the group of the highest-cost funds had a success rate of only 23.57 per cent.
In concluding his article, Kinnel quotes Vanguard's founder Jack Bogle: In investing, "you get what you don't pay for".
In other words, investors who choose high-cost investment funds in the expectation of superior returns are likely to be disappointed. Costs really matter.