GETTING STARTED Growing a Fund Portfolio Demystifying the Mutual Fund Why Mutual Fund Expenses Matter The ABCs of Mutual Fund Share Classes MORE... FUND TOOLS Kiplinger's Mutual Fund Finder How much do fees affect my return on my fund? Which is better: load or no load? How do growth and income funds compare? What is my return if I sell my fund now? Which fund is better?

BASICS
Why Mutual Fund Expenses Matter

How many times have you heard an ad pitch that goes something like this: "We deal in volume and pass the savings along to you!" Now imagine the same guy saying, "We deal in volume and pass the savings along to ... us!" That may be the secret snicker of your mutual fund company.

The question is, what are you going to do about it?

As the fund industry has grown so have the average expenses charged to stock-fund investors. The typical expense ratio for domestic equity funds is now at about 1.4%. For bond funds it's 1.1%. International funds have higher expense ratios, averaging around 1.9%.

Higher expenses hurt fund returns

By definition, expenses nip a percentage of your mutual fund assets each year. The higher the expense ratio, the harder it is to beat market indexes or category averages.

You're probably saying, I know that, I know that.

But the extent to which returns dwindle because of higher expenses may surprise you because the expenses are deducted before the fund reports results to shareholders.

We divided the bulk of long-term-growth funds into two groups: those with expense ratios above the average for the category and those with ratios below the norm. On average, those with lower expense ratios returned two percentage points a year more than funds with above-average expenses the past five years.

So if you dropped $10,000 into a higher-expense long-term-growth fund five years ago, you'd have about $1,500 less today than if you'd invested in a lower-expense fund. And if you were saving for a long-term goal -- say, retirement 25 years away -- you'd have 50% more at the end of that time with the lower-expense fund. (This assumes a 10% return for the high-expense fund, versus a 12% return for the low-expense fund.)

The results are the same in virtually every other fund category -- the low-expense funds return more, on average, than the high-expense funds. The exception is high-quality corporate-bond funds. In that category, the high-expense funds do better.

The bigger the fund, the higher the expenses

You'd think low-return, high-expense funds would shrivel up and die as smart investors left them for their cheaper competitors. But a study done by Jack Aber, professor of finance at Boston University, shows exactly the opposite is true: As fund size increases, fund expenses tend to rise rather than fall. The sad truth, Aber says, is that fund companies "aren't terribly motivated to compete on expenses because people don't seem to care."

Who will save you?

Fund expenses are broken into three categories. The largest is usually the management fee, which pays for the marketing and expertise needed to run the fund. Shareholders must approve an increase in this fee, and we have yet to hear of an instance when they refused. The rest goes for nuts and bolts -- such as trading securities, paying legal fees and providing services to shareholders. In addition, some funds assess 12b-1 fees, also to pay marketing costs, which include payments to brokers for selling shares.

Don't count on independent trustees at mutual fund companies to ratchet down expenses. John Bogle, chairman of the thrifty Vanguard Group of funds, says that compensation for directors at the ten highest-paying fund companies is more than double the average at the ten best-paying Fortune 500 companies. That's a strong incentive not to rock the boat, Bogle says. Plus, he says, lowering expenses would have a cataclysmic effect on a fund company's profits and the value of the enterprise.

The only other player with a sword big enough to slay the expense dragon, the Securities and Exchange Commission, so far hasn't focused on expenses.

To become part of the revolt, you must first identify the enemy. Take the number of dollars you have in a mutual fund and multiply that by the fund's expense ratio to learn how much you're spending for investment management. Then search for a fund with similar or better returns and risk profile but lower expenses, and make the same calculation. The difference is money in your pocket. If it's enough of an incentive, make the switch.

[ Top ]