There are two common variations of roulette tables at casinos. The first has 36 numbers and a single green zero. The second has a green zero and a double green zero. Winning number bets in roulette generally pay 35 to 1. Your expected return on the first table (single zero) is -2.7%. Your expected return on the second table (two zeroes) is -5.26%. Which wheel do you want to play? If you are the house (or own stock in the casino company), which do you want people playing?
This is similar to the decision investors face when evaluating investing costs. You certainly still have a "chance" of winning on the table with two zero's, but wouldn't you rather play the single zero table, or better yet a zero zero table? Buying a mutual fund with an upfront load (or 12-b1 fees) through a stockbroker is similar to playing the roulette wheel with two zeros - they both have a significantly lower expected return and probability of success.
Imagine roulette wheel A that has 36 numbers with no zeroes and pays 37 to 1 for wagers on the right number. That would make it a positive sum game. One way to play that table would be to put one chip on each number. You would wager 36 chips and be guaranteed to get 38 back. That would be roughly a 5.5% return for each round. If table B had 36 numbers plus one zero, you'd have a 2.77% expected return. If Table C had 36 numbers and two zeros now you'd be facing an even money proposition or zero sum game. If you assume real returns in the stock market are going to be about 5.5-6%, passively investing in the stock market is similar to buying all the numbers on wheel A. If you had investment costs from active management or other costs of about -2.8% it would be similar to playing the B wheel. Paying a 5.75% front end load to purchase a mutual fund would be similar to playing the C wheel.
Links
