There are two young co-workers, Mark and Lizzy, who are both serious about setting aside money for the future. After doing some research, Lizzy finds a reputable blue-chip dividend mutual fund and decides to open with a modest $1,000 investment. After that, she contributes $100 from every bi-weekly paycheck.

She doesn’t see much accumulation at first. But over time, her account value starts to build.

[ad#Google Adsense 336×280-IA]After 25 years at an average compounded annual return of 8.0% after expenses, Lizzy would be sitting on a nice sum of $204,722.

Meanwhile, across the office, Mark finds a similar equity income fund and invests the same amount.

His fund delivers an identical annual return, with one difference.

It carries an extra 50 basis points (one-half of one percent) in additional yearly fees and expenses.

Because of that extra drag, Mark’s account grows to just $189,644 over the same time frame — a difference of more than $15,000.

For the sake of illustration, let’s suppose we start with a $10,000 upfront investment and assume a stronger annual return of 9%. Under that scenario, the two accounts would grow to around $316,000 and $290,000, respectively — a difference of $26,000.

And keep in mind, that $26,000 will itself earn dividends and interest, widening the gap even more going forward. Clearly, Lizzy would have a nice head-start in retirement. Not because she earned a higher return, and not because she sacrificed and saved more money each month — but simply because she paid attention to the impact of fees.

This little anecdote plays out in the real world every day. We don’t always talk about fund management fees, brokerage commissions and other frictional trading expenses. But over time, they steadily chip away and erode the value of your account. So minimizing them can literally make the difference between an early retirement and working several more years.

It might also mean more lavish vacations, or more trips to visit the grandkids.

I’ve spent almost two decades analyzing the returns of different fund groups. I can tell you that in any given year, the spread from top decile (best performing 10%) to bottom decile (worst performing 10%) in any category can be extreme.

Last year, the Columbia Small Cap Value (CSMIX) posted a return of 32.3%, landing near the top of its class, while a bottom-dweller like Diamond Hill Small-Cap Fund (DHSCX) returned just 14.1%. These two competitors were separated in performance by more than 1,800 basis points. But you’ll find that over longer periods of 10 to 20 years, the difference from top to bottom narrows considerably. In many cases, it might be just one percentage point or less — and much of that can be explained by fees.

Let’s be clear, I’m not saying that fees need to be your primary consideration. Some talented portfolio managers are worth every penny they charge — outrunning their respective benchmark indices even after fees are assessed.

John Hancock Premium Dividend (NYSE: PDT), a member of my High Yield Investing portfolio, levies an annual fee of 1.4%. That’s not the cheapest around. But the fund’s 10-year average annual return of 12.14% ranks in the top 1% of its category. So it’s well worth the premium price tag.

That being said, this is often the exception, not the rule.

A fund that charges an extra half-point (or more) over the norm has a big handicap to overcome each year just to keep pace with cheaper peers. Those fees will also take a larger bite out of your income. A fund might earn 4% in dividends and interest from its portfolio of stocks and bonds, only to see 1% of that go to fees, cutting the net payout by one-fourth.

On the flip-side, a fund that charges less has a built-in advantage — like a race horse carrying a 100 lb. jockey instead of a 120 lb. jockey. After extensive studies, Morningstar concluded that “expense ratio is the most proven predictor of future returns.”

With all this in mind, here are a few proven funds with yields up to 6.6% and light expense ratios that let you keep more of what you make.

Investing is one of the few places where you get what you don’t pay for. In other words, every penny saved in expenses is a penny that stays in your account and keeps on earning more dividends.

Morningstar analyzed some numbers and found that over the long-haul, the cheapest quintile of funds produced higher total returns than the most expensive quintile across every single asset class.

It’s generally understood that passive exchange-traded funds (ETFs) charge lower fees than traditional mutual funds. And I have a few of these popular vehicles in my portfolio. But for the purposes of today’s essay, I was strictly looking at mutual funds — stock funds specifically. We may look at bond funds and multi-sector balanced or asset allocation funds another time.

You’ll notice that the yields on a few of these like the American Funds Income Fund aren’t exceptional. But when you add in capital gains, the fund’s total returns have beaten 97% of its peer group over the past 15 years — which helps explain why it has attracted over $100 billion in assets.

Don’t let anyone ever tell you that active funds can’t beat an index. American Funds operates 18 low-cost stock funds, 17 of which have beaten their indices since inception (some dating back 80 years).

But this screen also shined the spotlight on a fund that I’m not familiar with, and one that I may highlight in a future issue of High-Yield Investing — the Henderson Global Equity Income, whose quarterly dividends of $0.096 per share throw off a yield above 5%. Yields in this range are exceedingly rare for equity mutual funds, as the vast majority belong to closed-end funds that utilize riskier techniques (like leverage).

But this 5-star fund does it the old-fashioned way, by hand-picking an international portfolio of 80 high-yield stocks such as Royal Dutch Shell and Singapore Telecom. There is an upfront sales charge, but it may be well worth it. The fund has a low $500 minimum initial investment.

— Nathan Slaughter

Sponsored Link: If you’d like to gain access to future picks, as well as my entire portfolio — consisting of some of the most unique (and safe) income instruments around — then I invite you to consider joining us at High-Yield Investing. For more information, simply click here.

Source: Street Authority