Real-World Example of Why High-Cost Index Funds Are The Worst


Here’s another reminder that in the world of investing, having low costs is more important than owning “passive” index funds. Why? The simplest argument is that index funds can have high expense ratios.

Anyone can open an account at Vanguard, Schwab, Fidelity, or TD Ameritrade and purchase an S&P 500 index fund with expenses of about 0.05% a year. That works out to $50 a year on a $100,000 balance.

Meanwhile, the following companies have the most expensive S&P 500 index funds on the market. These happily charge you $1,000 to $2,300 a year on a $100,000 balance while investing in the same companies in the same amounts. Credit to Meb Faber for compiling this list.


These could be considered the worst mutual funds out there. Why? If you buy an actively-managed stock-picker fund, at least you have the possibility of outperformance (for a little while at least). You bet on red in roulette even though there is zero and double-zero. With an expensive index fund, you have zero upside. You can’t win. You didn’t even bet on double-zero. Instead, you essentially lit 1% of your money on fire.

Let’s look at the real-world performance of Rydex S&P 500 Fund (RYSYX) and the Vanguard 500 Index Fund (VFINX). Here’s a Morningstar chart showing the relative performance of the Rydex S&P 500 Fund (RYSYX) and the Vanguard 500 Index Fund (VFINX) from the inception of the Rydex fund in mid-2006. This is a “Growth of $10,000” chart, and you can see how the gap just keeps widening over time.


Here’s a quick takeaway from this chart:

  • Someone who invested $100,000 in the Rydex S&P 500 Fund (RYSYX) from 5/31/06 to 5/21/17 (~11 years ago) would now have $185,183.
  • Someone who invested $100,000 in the Vanguard 500 Index Fund (VFINX) from 5/31/06 to 5/21/17 (~11 years ago) would now have $235,948.
  • That is a difference of over $50,000 with no luck involved as both are passive funds that that legally promise in their prospectus to track the S&P 500 index.
  • Let me repeat: That’s a difference of $50,000 on a $100,000 starting balance over only 11 years! That is real money; actual dollars that someone will not have to spend in retirement. Imagine what that number could grow into over 30 years of saving.

Isn’t that horrible? Now, consider that the reason why someone would buy these funds in the first place was probably due to a human advisor putting their client in such a fund. Therefore, there is the possibility of another layer of advisor fees on top of the fund expense ratios. (Or they could be options in a bad 401(k) plan. It would be really scary if these were the best options on a plan menu.)

I can’t understand how these companies can get away with charging so much for doing so little. According to Morningstar, the State Farm S&P Index fund (SNPBX) currently has $1.4 billion in assets and the Invesco S&P 500 Index fund (SPICX) has $1 billion in assets. Billions of dollars? Why are so many people buying this stuff?!

Real-World Example of Sequence of Returns Risk


The standard investment advice is the older you get, the more bonds you should hold in your portfolio. There are various rules of thumb like “Age in Bonds” or “Age minus 20 in Bonds”, and so on. On the other hand, stocks have higher historical long-term returns, so shouldn’t we keep as much in stocks as we can?

It’s not just about the long-term average return, you also have to worry about the sequence of returns. I’ve shared a hypothetical example of sequence of returns risk before, but Will Street Project has a great post called Why Drawdowns Matter that illustrates this effect using real-world numbers.

From 2000 to 2016, the overall total return of the S&P 500 Index (large US stocks) and the Barclays US Aggregate Bond Index (broad US bonds) was roughly the same. The sequence for stocks was bad then good. The sequence for bonds was basically a slow, gradual line upwards. Stocks thus lagged bonds for most of the period but caught up and even surpassed bonds a bit by the end.

Here’s what would have happened if you started with $100,000 in either the S&P 500 or the US Aggregate Bond Index and kept on buying $500 per month:


Here’s what would have happened if you started with $100,000 in either the S&P 500 or the US Aggregate Bond Index and kept on selling $500 per month.


The difference is that in the top chart you are adding money (and thus buying stocks at a lower price during the bear markets), while in the bottom chart you are taking out money (and thus selling stocks at a lower price during the bear markets).

It is important to note that things would look different if stocks shot up initially and then tapered off, as opposed to stocks struggling initially but then going back up at then end of the period. However, we can’t control the sequence of returns in our own retirements, so we have to be prepared.

One solution is to hold more bonds (or single-premium immediate annuities). Another solution is to use a dynamic withdrawal strategy so that you’re taking out less money during a down market.

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