Same Fund, Different Investment Returns — How Costs Can Actually Reduce Returns

While not apparent, mutual funds carrying the same name can yield different returns due to investment costs. In Can Women Actually Retire Successfully by Investing in Gender Equality?, I highlighted the Calvert International Equity Fund was listed four times on the list of highest Gender Equality ratings.

Curiously, each of these had different letters at the end of their name. They also had different expense ratios. Notice that the returns for the highest expense ratios are lower than those for the lowest expense ratios. An expense ratio is how mutual fund companies assess costs to investors for the work they do as well as the costs to get their funds out to you.

Simply put, depending upon the distribution channel and how much of a mutual fund is being purchased, the costs may vary. This varied cost by distribution channel can be compared to buying toilet paper in various locations. At a convenience store, a single roll is typically more expensive than if you bought multiple rolls (in a pack) at a grocery store. If you purchased in even higher volume, say at Costco, the per unit cost would be even lower. However, you may have a storage problem or may need to invest in more space to accommodate the larger purchase!

Share classes, distribution partners and expense ratios

Expense ratios can be associated with share classes. Share classes vary from one another based on their annual operating expenses, sales charges and commissions, and account-level fees. This fund has four share classes: the A share, C Share, I institutional, and the Retirement R6. Note that each share class above has its own ticker symbol.

According to Morningstar, A shares are usually the most cost-effective for long term investors who are using a commission-based broker to transact. Often there is an investment minimum of $2,500 or less.

Typically, the maximum initial expense (non-refundable deposit) is between 4% and 5.75%. You may have heard of this referred to as a front-end load. There is an ongoing fee to the broker between 0 and .5%. This is known as a 12b-1 fee. This fee pays a mutual fund’s distribution costs. It is often used as a commission to Registered Representatives (brokers) for selling the fund.

C share classes typically have investment minimums that are the same as A shares. They do not include a front-end sales charge, but their expense ratio is higher than the A share. This sales charge is typically an annually recurring fee of 1% used to compensate Registered Representatives.

R share classes are available through retirement plans. Employers that sponsor retirement plans for their participants buy these shares. The fees that these funds charge range widely. It is common to see R1 to R6 share classes vary in expense ratio by 1.0 percentage point.

Large institutional buyers purchase the I share class. They have low if not the lowest expense ratios. Typically, the investment minimum is $250,000 or more. Investment advisor representatives and investment consultants use the I share class and add their fee on top of these mutual funds.

Get a fund fee x-ray

Expense ratios influence investment returns. The Financial Industry Regulatory Authority offers this FINRA Fund Analyzer to help evaluate expense ratios. The fee analyzer starts by making the initial investable amount, investment return expectation, and the inception date are all the same.

This example assumes $10,000 invested over 10 years, with a 5.0% expected investment return. These are the results from my March 13 use of the analyzer. The page number referred to later comes from printing that to an Adobe .PDF file.

Share class costs for Calvert International Index Fund

Based on this hypothetical situation, there is a $1,118 difference between the highest and lowest expense ratio. If you did know the investment adviser representatives fee, you could add it for a true apple to apples comparison.

However, we should look at the actual returns, not the assumed return to isolate fees. Morningstar provides that data on page 15 of the analysis.

Average annual return as of March 13, 2022

The chart shows that the investments with the lowest expense ratios have the highest returns. This result is expected given that the fund invests in the same companies in the same proportions varying only by cost. However, that may not be the case when comparing different investments from different companies.

How should costs actually affect your investment decision-making?

Cost is just one of the factors you should consider when investing. My discussion started with a desire to invest in mutual funds with A grades on gender equality. That may be the reason you choose a mutual fund.

Based on your situation you may not have a choice of share class. This should not stop you from investing in your preferred fund. The more challenging issue may be to find investment choices that align with your values.

You may find yourself being able to overcome this by investing more money or stretching out your time horizon. I hope this makes you a smarter investor in pursuit of your goals, aligned with your values.