How Fund Fees are the Best Predictor of Returns

A fund's annual fee is the most proven predictor of future fund returns, says Morningstar's Russel Kinnel - and here are the stats to prove it

Russel Kinnel 4 October, 2016 | 11:08AM

This article is part of Morningstar's Guide to Passive Investing, helping investors make smart choices to meet their long-term investment goals.

If you’ve been following Morningstar’s research for long, you know how important we think the cost of investing is. The expense ratio is the most proven predictor of future fund returns – and our data agrees. That’s also what academics, fund companies, and, of course, Jack Bogle, find when they run the data. But it’s been a couple of years since I provided the proof, so we have updated my data to show just how strong and dependable fees are as a predictor of future success. That’s not to say investors should only consider cost when selecting a fund. There are many other variables, but investors should make expense ratios their first or second screen.

How We Ran the Test

To begin any test of predictive power, we use historical data so that we are using data investors would have had access to at the time. That includes funds that no longer exist. In fact, that’s a key part of the story because higher-cost funds are much more likely to fail and be merged away. If you do not factor them in, you will see better performance from higher-cost funds than was the reality, as those that survived naturally are more likely to have produced better performance – while so many failures have been culled.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Russel Kinnel  is Morningstar's director of fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping US investors build winning portfolios.

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