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Example 3 . 5 You are considering an investment of 1 0 , 0 0 0 in a mutual fund for the purpose of adding
Example
You are considering an investment of in a mutual fund for the purpose of adding to your retirement income, you expect to retire years from now. You are choosing between an index tracker fund and an activity managed fund. The index tracker fund has no initial charge, an annual management charge of of the value of the fund, and other costs including brokerage fees amount to pa
The actively managed fund has an initial charge of of the value of the investment, an annual management charge of of the value of the fund, and other costs including brokerage fees amount to pa of the value of the fund. You have read that over the long term the average real rate of return on a balanced portfolio of shares has been pa
You expect that performance to continue for the next years, on the assumption that the funds match the general market performance.
Required:
a What is the annual total expense ratio including the brokerage fees in each case?
b What do you expect the value of the index tracker fund to be after years?
c What are the effects of the expenses on the expected average annual return of the tracker fund?
d What do you expect the value of actively managed fund to be after years?
e What are the effects of the expenses on the average annual return of the actively managed fund?
f What would be the effects of charges on the expected average annual returns of each fund if the investment horizon were years rather than years?
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