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Assumptions In This Study
The
assumptions underlying this study are crucial to understanding
the results. Here is what I assumed for the equity part of the
portfolio:
Benchmark: Investor
pays a 5 percent load in a large-cap blend fund with expenses
of 1.18 percent (the Morningstar average) and a return (after
expenses) of 11 percent.
No-load fund:
Still a large-cap blend fund, but expenses drop to 0.84 percent
(the Morningstar average), boosting return to 11.34 percent.
Elimination of the load means more money is invested each year,
for example $2,000 is invested at each birthday from 21 through
29 instead of only $1,900.
No-load index fund:
Investor uses the Vanguard 500 Index Fund, with expenses of 0.18
percent. This boosts return to 12 percent.
Four-way diversification:
Expenses rise to 0.23 percent (the average of Vanguard's
index funds in the four asset classes) while return from the
four funds rises by two percentage points, to 14 percent. The
net effect of these higher expenses and higher returns is a return
of 13.95 percent.
Bonds: I know
it is not realistic to assume an investor remains 100 percent
committed to equity funds over a lifetime. So I assumed she shifts
an increasing portion of her portfolio from equity funds to bond
funds, as she gets older.
The investor's portfolio
is 100 percent equities until her 50th birthday, at which time
she invests 15 percent of the portfolio in bond funds. At age
60, 30 percent of the portfolio is switched into bond funds;
and from age 70 forward, she balances the portfolio 50/50 between
bond funds and equity funds. This, of course, will not fit everybody's
comfort level, but it is a reasonable way to reflect real-world
investor behavior that I believe makes good sense.
Using the benchmark,
I assume she pays a 4 percent load on bond funds with expenses
of 1 percent and an after-expenses return of 5 percent. Once
she moves to a no-load bond fund, I assume her expenses drop
to 0.68 percent and therefore her return rises to 5.32 percent.
Using an index fund, her expenses fall to 0.17 percent, increasing
her return to 5.83 percent.
