Do Mutual Fund Fee's Matter?

[km4hr]

I read almost everywhere that high mutual funds fees are to be avoided. Why is that? Isn't overall return all that really matters? What' the problem with high front end loads and expense ratios? If a fund gets superior overall results why do I care how much the fund's manager makes? I'm sure I must be missing something because independent advisors seem to be pretty unanimous about this.

 

[brewer12345]

The problem is that virtually nobody in the equity mutual fund world consistently beats index funds after the extra costs that are charged for active management. Those that do are usually hired away by hedge funds, etc. that can afford to pay more for top talent.

 

[TromboneAl]

The answer is the load funds do not get superior results.  So you're better off not paying higher fees.  Advisors are unanimous because that's how they make their money.  

 

[justin]

Pretend investing is like gambling. Except in this form of gambling, you can beat the house. Now you get to pick how much the house charges you for the privilege of gambling. Do you want to pay the house 0.2% annually of everything you bet? Or do you pay the house 5.75% up front for the privilege to play, then 1.2% annually?

We're all playing pretty much the same game. Some of us pay more to get in the door to the casino.

 

[mickeyd]

If a fund gets superior overall results why do I care how much the fund's manager makes? I'm sure I must be missing something because independent advisors seem to be pretty unanimous about this.

km,

I like Justin's gambling analogy a lot.

Another way to look at it is that if an investor knew for sure that he could receive a superior return from a manager that charged, say 200bp for expenses,  and that return could produce this elevated return over the long term (15-20 years), it may be worth the extra expense.  The only problem is that you would have to wait 15-20 years to know that your risk had been rewarded by the increased return that the manager' actions  brought to the fund.

Even if there were a fund that had a past history of beating the benchmark (index) over the last 15 years, there is no way that I know of to guarantee that these returns will continue for even one more year, not to mentioin 15 more.

On the other hand, passive investing does not try to beat the benchmark at all.  It only tries to match it, less expenses. If expenses are only 20bp, many long-term investors think that investing in mutual funds that have relatively low costs is a wise move to make.

In any given year, there are only about 25% of equity funds that beat the S&P 500 benchmark. There are very few that will beat it 2 years in a row and, as time progresses, the % becomes zero.

 

[JohnP]

km -

We're retired - when I think of annual fund expenses, I immediately relate them to the SWR (Safe Withdrawal Rate) that determines how much we can draw from savings to live on during retirement.  On this forum, the generally acknowledged SWR is 4%.  A 1% annual expense is a small number compared to a portfolio but is a 25% hit to a retirees SWR.  So, if I have the option of putting retirement savings in funds that have .2% annual expenses versus 1.5% plus a .25% 12b charge annually, I'm going to go for the lower-expense fund and and hope that I can bank the difference - reducing my risk of running out of $ before I pass away and/or giving me more to live on.

I do agree with all of the above posts comparing overall performance potential of the high ER funds to the low cost funds.   The salesperson's arguement that high performance is associated with high expense funds is a big bunch of baloney.

JohnP

 

[vinhmen]

Someone posed a variation of this question to Scott Burns recently, you might be surprised at his answer:

http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/
columns/2005/stories/DN-burns_17bus.ART0.State.Edition2.177f54c2.html

Hold on to a hand like this one

10:19 AM CST on Thursday, November 17, 2005
Scott Burns

Question: I have my 401(k) divided across four Fidelity funds: Value, Balanced, Diversified International and Contra. Its management fees range from 0.67 percent (Balanced) to 0.94 percent (Contra). Based on the above choices and management fees, would you recommend that I try your "Margarita Portfolio" approach?

My thinking is that the above four funds give me good diversification and overall good returns annually.

B.J., by e-mail from Dallas

Answer: Don't do a thing. You've got a hot hand. Or your plan sponsor has.

Either way, your account is the exception that proves the rule – your fund managers are adding value while collecting reasonable fees.

Fidelity Contra, the best of your funds, is rated five stars by Morningstar. It has ranked in the top 5 percent, 15 percent, 1 percent, 3 percent and 2 percent of all domestic large growth funds over the last 12 months, three years, five years, 10 years and 15 years, respectively. At its worst the last three years, it has returned 1.89 percent a year more than the S&P 500 and has done better than 85 percent of its competition.

Fidelity Balanced and Diversified International are also solid top-quartile funds, rated five stars by Morningstar. The weakest fund in your portfolio is Fidelity Value, a four-star fund that has been in the bottom 50 percent of its peer group in six of the last 10 years.

Categorized as a mid-cap value fund, it has done better than the broader S&P 500 index over all time periods, largely because of the stock universe from which it selects. But it has also managed to be in the top 50 percent of its peer group over all trailing time periods ending Sept. 30. (This wasn't the case in other trailing time periods. From 1996 through 2000, it was in the bottom 50 percent of its peer group in each year.)

Rather than thinking about indexing, you should start monitoring your funds on a regular basis so you'll know if any need to be replaced with another managed fund or an index fund. There are several good tools for this.

One good source is www.fund alarm.com, an independent Web site that tracks fund performance over different time periods and ranks poor performers as one-, two- and three-alarm funds. When a fund has become a three-alarm fund, trailing its category index for three time periods, fundalarm.com publisher Roy Weitz says you should consider selling the fund.

In addition to providing very valuable information, Mr. Weitz has a great sense of humor. In his site bio, he observes, "On the day that I was born, in New York, Elizabeth became Queen of England. She's looking a lot older, and so am I, but I've been less embarrassed by family members."

Morningstar data on funds are available on its site, www.morning star.com, and on MSN Moneycentral at moneycentral.msn.com/ investor/home.asp.