Common Sense on Mutual Funds, Updated 10th Anniversary Edition

by John C. Bogle

Here is one example, assuming a nominal annual return of 10 percent on stocks. An equity mutual fund incurring annual expenses at the industry average would lop off some two percentage points—fully one-fifth of the market’s annual return. Now let’s say that inflation is 3 percent; then the market’s real return is 7 percent, and costs would consume nearly one-third of the market’s reward. And taxes must be paid—sooner or later—by the investor. Fair or not, taxes are assessed, not on real returns, but on the (higher) nominal returns. If taxes on fund income and capital gains distributions are assumed to reduce pretax returns by, say, another 2 percent to 5 percent (a rather modest assumption), that 2 percent all-in cost of a mutual fund could consume fully four-tenths of the market’s net real return after taxes. To state the obvious, the long-term investor who pays least has the greatest opportunity to earn most of the real return provided by the stock market.

Costs paid by the Investor = Expense ratio + Transaction costs + Taxes on Income and LTCG. Considering inflation and Market returns which cannot be controlled. An investor who pays least cost gets the best return.