Mailbag: Which Investment Fund Should I Purchase To Minimize Fees?

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I have a choice between four different healthcare investments. Each has a different set of expense ratios and transaction costs.

  1. VGHCX: I can purchase Vanguard Health Care Inv (VGHCX) at Vanguard for no transaction fee. It has an expense ratio of 0.36%. I am investing enough for the $3,000 minimum purchase.
  2. VGHAX: I can purchase Vanguard Health Care Adm (VGHAX) at Schwab for a transaction fee of $30. It has an expense ratio of 0.31%. Since I am investing through an investment advisor, my small investment is aggregated with everything else the investment advisor is managing to satisfy the $50,000 minimum purchase.
  3. VHT: I can purchase Vanguard Health Care ETF (VHT) at Schwab for $8.95. It has an expense ratio of 0.09%. Since my account is new,  Schwab has a promotion whereby equity purchases are free for the first year. Sells will still incur the $8.95 transaction fee.
  4. RYH: I can purchase Guggenheim S&P 500 Eq Weight HC ETF (RYH) at Schwab with no transaction fee for buying or selling. It has an expense ratio of 0.40%.

It seems like option 3 (VHT) is the best deal. Am I missing anything?

Option 1 and Option 2 (VGHCX vs. VGHAX)

The choice between option 1 (VGHCX) and option 2 (VGHAX) is easy to compute since these are flavors of the same fund. The difference in expense ratios is only 0.05% and the trading fee is $30. If you divide $30 by 0.0005 you get $60,000. Investing $60,000 would justify the $30 purchase fee in the first year of lower expense ratios ($60,000 times 0.05% equals $30). Then it would take another year of holding the fund until the $30 fee to sell the fund would be justified. Holding $60,000 of VGHAX for more than two years would justify paying $30 for the purchase and $30 for the sell.

Since you are only purchasing a small amount, option 1 (VGHCX) is preferable to option 2 (VGHCX), eliminating VGHCX.

Option 3 and Option 4 (VHT vs. RYH)

If we assume that option 3 (VHT) and option 4 (RYH) are similar funds, the choice between them is also easy to compute. The difference in expense ratios is 0.31% and the transaction fee is $8.95 only if VHT is sold.  Purchasing $2,887.10 of VHT and holding it for one year justifies paying $8.95 by having a lower expense ratio ($2,887.10) If you are investing more than $3,000, option 3 (VHT) is better than option 4 (RYH).

However, there is a slight difference between VHT and RYH. Although they are both U.S. only healthcare investments, VHT is cap-weighted while RYH is equal weighted. Over the past 5 years, VHT has a 20.41% annualized return while RYH has a 19.27% annualized return, giving VHT an edge.

Normally equal weight investments should do better as they have more invested in smaller mid-cap stocks. The 1.14% excess return for VHT is probably due to the fact that recently large cap has done better than small cap during the past five years as the dynamic tilt would have suggested it would.

Option 1 and Option 3 (VGHCX vs. VHT)

Finally, let’s compare the “winners.”  The choice between option 1 (VGHCX) and option 3 (VHT) is more difficult since these are different investments. VHT is an index exchange traded fund while VGHCX is an actively managed mutual fund. But the difference in returns stems from the fact that the VHT contains only U.S. and follows the MSCI US Investable Market Health Care 25/50 Index while VGHCX has always included foreign healthcare stocks, and currently comparing itself against the MSCI All Country World Health Care Index.

Due to these differences, during the time both started running (1/31/2004) through 9/30/2016, VGHCX had a 1.67% annualized average (11.17% compared to VHT’s an annualized average of 9.50%).  Yet, over the most recent 5 years VHT beat VGHCX by 0.65% as VHT had an annualized return of 20.41% and VGHCX had an annualized return of 19.76. VGHCX has to over come a 0.25% annual head start that VHT receives simply because it has lower expense ratios.

So how do we decide between them? For small amounts I would choose the fund with the lowest possible transaction costs. Funds go down as easily as they go up and you want to be able to inexpensively sell them in order to realize capital losses on your taxes. This favors VHT slightly.

Additionally, if you are purchasing in a taxable account, this also favors the exchange traded fund, VHT, since VGHCX will realize capital gains each year.

For these minor reasons, I would suggest purchasing VHT.

Photo used under Flickr Creative Commons license.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.