Index Funds are widely known for low expenses. But do the low expenses listed by the Index Fund firms accurately reflect the complete costs investors pay? Wintergreen says No. Index Fund investors simply don’t see the full costs they’re paying.

The underlying securities of the BlackRock, State Street and Vanguard Index Funds based on the S&P 500 Index have hidden costs that must be earned before holders receive investment returns. These “look through expenses” come from two sources: the average annual dilution of company shares issued in executive compensation plans, and the buy back of company shares that are used to offset this dilution.

WHAT YOU THINK YOU PAY People who invest in these funds believe their expenses to be small and manageable. 0.13%1
DILUTION FROM COMPENSATION PLANS The annual dilution of company shares issued for executive compensation can increase expenses an extra 2.5%. 2.5%
BUYBACKS TO OFFSET DILUTION Ongoing company share buybacks to offset dilution can increase expenses up to an additional 1.6% 1.6%
INDEX FUNDS LOOK THROUGH EXPENSES AVERAGE A TOTAL OF 4.2%

Look through expenses are higher than advertised fees. 95% of the time Index Funds vote in favor of executive compensation creating ever increasing look through expenses.

INDEX FUNDS CONCENTRATE RISK RATHER THAN DIVERSIFY IT.

FANG AND FRIENDS2:

These 10 stocks have an average P/E ratio of over 180x3. They represent 2% of the S&P 500 and generated 62% of the Index’s return for the past 16 months4.

THE OTHER 490:

The other 490 stocks have an average P/E ratio of 24x, represent 98% of the S&P 500, and generated 38% of the Index’s return over this same period.

Index funds have been sold as both safe and inexpensive investments. We believe they are neither. These funds are risky due to the concentration in the FANG and Friends. They’re not inexpensive due to the costs of look through expenses.

Look Through Expenses:

Look Through Expenses

1 Average fee, based on the following index funds: Blackrock “Core”, State Street Average, and Vanguard Average. 1/1/15-4/30/2016.

2 “FANG and Friends”: Alphabet, Amazon, Apple, eBay, Facebook, Microsoft, Netflix, Priceline, Salesforce, Starbucks.

3 As of April 30, 2016.

4 Period from January 1, 2015 to April 30, 2016.