By CHUCK JAFFE
Two new studies show that mutual fund investors paid less, on average, for their funds last year, continuing a long, slow trend.
That news, released in separate studies from the Investment Company Institute and investment researcher Morningstar Inc., should raise three questions for fund investors:
1. What do my funds charge and are they part of the low-cost trend?"
2. Am I paying too much?
3. Could I pay less without damaging my portfolio, asset allocation or emotional security about my strategy and plans?
Before answering those questions, you must first know something about the results of those studies.
According to the ICI's "Trends in the Fees and Expenses of Mutual Funds" study for 2011, the average expense ratio paid by equity fund investors was 0.79%, down from 0.83% in 2010. Over the last two decades, average expense ratios paid by equity-fund shareholders have fallen by 20%. In bond funds, according to the ICI, the average cost was 0.62%, down from 0.64% a year earlier.
Morningstar's annual survey of fund expenses conducted by Russel Kinnel, the firm's director of mutual fund research, produced similar results, except that it lumped fund types together, pegging the average expense ratio paid by shareholders at 0.75% in 2011, down from 0.77% a year earlier.
Kinnel noted that the average investor is paying 0.19% less in expenses than they did less than a decade ago.
Cheap and lowdown
A lot of things contribute to how expense ratios are calculated, not least of which is asset flows. While you might assume that lower expense ratios mean fund firms are cutting costs, that's not really the truth.
The typical investor is paying less because, increasingly, they have sought out cheaper funds.
Said Kinnel: "It's the choices made by investors that have had the greatest impact. Investors have generally invested new money in lower-cost funds within a category. In addition, the growing popularity of bond funds has meant that money is flowing toward the lowest-fee asset class, thus lowering the overall rate. "
That means the question of "What do my funds charge and are they part of the trend?" is as much about self-awareness as fund expenses.
There aren't many reasons to pay up for a fund. Unless it is in a space like alternative investments or emerging markets where research costs are higher and the entire category charges more than normal, investors should remember that extra expenses come directly out of their pocket.
If a fund is raising its costs, look into why that is happening. One way costs rise is that other shareholders lose faith and bail out, dropping the asset base and increasing costs for those left behind. If your costs are up, and performance has been down, you may be left holding the bag.
The second question "Am I paying too much?" involves trying to be at or below the average expense level. One key in both of these studies is that they look at what the average shareholder is paying, and not at what the typical fund is charging.
According to Morningstar, the average equity fund carries a 1.37% expense ratio, while the typical bond fund charges 1%.
To pay any more than those levels, an investor should have a compelling reason. For some, it may be that they have nothing but high-cost options in their company's retirement-savings plan and an expensive option is better than nothing; for others, there is a specific premise or money manager they will pony up for.
Barring a concrete reason to pay more, investors should always look to pay less.
That raises the third question: "Could I pay less without damaging my portfolio, asset allocation or emotional security in my strategy and plans?"
Investors have a tendency to fall in love with a company, a manager or a concept that first attracted them to a fund, and often think what they have is unique and special.
The truth is there are hundreds of plain-vanilla growth funds, but only a dozen strategies (at most) for managing that kind of fund. Likewise, while index funds are known for being inexpensive, you can find a range of expense ratios for funds covering the same index; an investor can switch to the cheaper fund without altering their index exposure.
If there's a lower-cost option that essentially does the same thing as a fund charging more, cut your costs.
Every investor knows that returns aren't guaranteed. They should remember that expenses are, because fund companies will collect on a fund's earnings before shareholders do.
If you want to live the experience of the industry trend and pay less for your funds, you have to make it happen.