Question Of The Month June 2010
How High Are Your Mutual Fund Fees?
Do you pay 1 or 2 percent in annual mutual fund
fees? Or is it 5, 10, 15 percent or more? Do
you know what you pay to invest in your mutual
fund? Are they too high? And for us --- the
planning, saving and investing for retirement
people, the percentage that we pay has an impact
on our nest egg.
Ian Salisbury, in his Wall Street
Journal column Fund Track, allows us to take a
look at this debate from a number of
perspectives. “Maybe
you really shouldn’t know because if you did,
you wouldn’t like the results.”
An investing web site---kaChing
----says that it is 3.3% of assets per year for
stock funds. However, The Investment Company
Institute, the fund industry’s trade
organization says that the charge is
less----1.17% per year. KaChing,
says prevailing estimates fail to quantify
factors like trading commissions and taxes,
which it plugs in to get its figure for the
average annual costs of actively managed stock
funds.
KaChing's 3.37% is more than
triple the 1% many analysts use as a rule of
thumb to denote high-cost funds. "Mutual funds
are promoted as having very low management
fees," says kaChing's chief executive, Andy
Rachleff. But those costs "are just the tip of
the iceberg."
For us
--- planning, saving and investing for
retirement people,
the stakes in the fees debate are
large. When you compound over a couple of
decades, the small differences in costs are
compounded over decades and that can amount to
tens of thousands of dollars.
The fees debate has attracted the
attention of the U.S. Supreme Court. They are
reviewing a case alleging that mutual-fund
companies take advantage of the complexity of
calculating mutual-fund costs to overcharge
investors. The NPR Blog notes that the Court is
unhappy that Oakmark family of mutual funds
charges individuals twice what it does
institutions like insurance companies and
pensions funds.
As part of the case, supporters
of the industry's position use the ICI's cost
estimates to argue that mutual-fund expenses
have fallen since the 1980s.
When you look at the two
positions, the biggest difference between the
kaChing approach to mutual-fund costs and the
ICI's is investors' tax liability. To kaChing,
taxes add an extra 0.94 percentage point to fund
costs.
An often-criticized aspect of
mutual funds is that investors can get saddled
with capital-gains taxes, even in years when
they don't buy or sell fund shares. That is
because mutual-fund investors must pay their
share of the capital gains that funds accumulate
through their own trading activity. This can
leave investors on the hook for trading profits
earned by a fund even in the years before they
became fund owners.
How the court will rule is this
case is not known but the case
highlights the conflict of interest that has
long plagued much of the fund industry. Most
funds have a financial incentive to charge the
highest fees they can, since that's how they
make their money. But at the same time they have
a fiduciary responsibility to put us planning,
saving and investing for retirement people
interests first.
It looks very different if you see fees as a
percentage of investment returns, which is a
much more appropriate view. Invest $100 in a
fund with assets that gain 10 percent and that
1.5 percent fee chews up 15 percent of your
profits. If the fund gains only 5 percent, the
fee comes to 30 percent of profits.
When you see fees as a portion of returns rather
than assets, it's easy to understand the
daunting challenge that fund managers face. If
the index fund returns 7 percent, the investor
ends up with 6.8 percent after paying fees of
0.2 percent. To match that after-fee result, the
managed fund must select holdings returning 8.3
percent. That means its return has to be nearly
19 percent better -- 8.3 vs. 7. But, will your
mutual fund sales person tell you that?
Probably not and that is why us planning,
saving and investing for retirement people need
to know and do all that we can to keep our costs
and fees as low as possible.
|
|
|
 |
|
Expensive Fund: 8%
annual return, 1.2%
annual expense ratio |
|
 |
|
Year |
Beginning balance |
Ending balance |
|
 |
|
1 |
$10,000 |
$10,670 |
|
 |
|
10 |
$17,932 |
$19,134 |
|
 |
|
20 |
$34,311 |
$36,611 |
|
 |
|
30 |
$65,651 |
$70,052 |
|
 |
|
40 |
$125,617
|
$134,038
|
|
 |
|
50 |
$240,356
|
$256,469
|
|
 |
|
Cheap Fund: 8% annual
return, no expenses |
|
 |
|
Year |
Beginning balance |
Ending balance |
|
 |
|
1 |
$10,000 |
$10,800 |
|
 |
|
10 |
$19,990 |
$21,589 |
|
 |
|
20 |
$43,157 |
$46,610 |
|
 |
|
30 |
$93,173 |
$100,627
|
|
 |
|
40 |
$201,153
|
$217,245
|
|
 |
|
50 |
$434,274
|
$469,016
|
|
 |
|
40 |
$201,153
|
$217,245
|
|
 |
|
50 |
$434,274
|
$469,016
|
|
 |
|
|