How to quantify differences in return with low expense ratio vs high expense ratio mutual funds?

Question

One often repeated piece of financial advice is to work to minimize your expense ratios in your mutual funds in order to maximize your returns.

While it is often straightforward to determine the expense ratio fee listed on a mutual fund, how can I get an apples to apples comparison between two stock funds to determine the actual ROI (return on investment) and IRR (interest rate of return) of each investment?

Is it as simple as comparing two mutual funds price/share over time? Or does one have to somehow deduct X.XX% off the top?

A numeric example would be helpful here. For the sake of simplicity, lets say the only expenses have to do with expense ratios - for a real world example, lets say I invested $100 into each of 2 index funds, VEIEX and VFIAX, on the following days (values are approximate)

VEIEX                
          $/share   Transaction Type  $ In or Out    # shares purchased  IRR
1-Oct-10    28.97   Fixed Buy         ($100)           3.451846738       0.602%
1-Nov-10    30.98   Fixed Buy         ($100)           3.227888961    
1-Dec-10    30.05   Fixed Buy         ($100)           3.327787022    
1-Jan-11    30.34   Sell All           $303.63       -10.00752272    

VFIAX                
          $/share   Transaction Type  $ In or Out    # shares purchased  IRR
1-Oct-10   105.53   Fixed Buy         ($100)           0.947597839       2.900%
1-Nov-10   113.03   Fixed Buy         ($100)           0.884720871    
1-Dec-10   113.17   Fixed Buy         ($100)           0.883626403    
1-Jan-11   116.99   Sell All           $317.74        -2.715945113    

Are my IRR calculations accurate? Do i somehow need to take into account the expense ratio for this?

Answer 1

Yes you should take in the expenses being incurred by the mutual fund. This lists down the fees charged by the mutual fund and where expenses can be found in the annual statement of the fund. To calculate fees and expenses.

As you might expect, fees and expenses vary from fund to fund. A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.

You don't pay expenses, so the money is taken from the assets of the fund. So you pay it indirectly. If the expenses are huge, that may point to something i.e. fund managers are enjoying at your expense, money is being used somewhere else rather than being paid as dividends. If the expenses are used in the growth of the fund, that is a positive sign. Else you can expect the fund to be downgraded or upgraded by the credit rating agencies, depending on how the credit rating agencies see the expenses of the fund and other factors.

Generally comparison should be done with funds invested in the same sectors, same distribution of assets so that you have a homogeneous comparison to make. Else it would be unwise to compare between a fund invested in oil companies and other in computers. Yes the economy is inter twined, but that is not how a comparison should be done.