There's no question that the past 18 months have been devastating to the stock market, and by proxy, the mutual fund industry which provides the investment vehicles so many investors use. Assets under management at leading vendors like Vanguard and Fidelity fell dramatically in 2008, as stock indexes plummeted and investors ran - not walked - to move assets from stock funds to money market and bond funds.

But there is a silver lining from all the doom and gloom of last year, and it starts with the fact that expense ratios reached their lowest level in decades during 2008, so says the Investment Company Institute (ICI). The average stock fund expense ratio fell to 99 basis points (or 0.99%) in 2008, as investors sought out cheaper index funds and no-load funds versus "loaded" funds, or funds that charge sales fees. (To learn more, check out The Lowdown on No-Load Mutual Funds.)

This continues a broader trend that has lowered the average expense ratio paid by investors to drop by 50% since 1980, according to the ICI.

Competition to Rear its Fee-Lowering Head
The mutual fund industry has taken notice, and companies are now competing for investors by either holding fees constant from last year or consciously lowering them further. After all, there are hundreds of mutual fund companies out there, and they're competing for an investor that is battered, bruised and nervous to invest. Annual fees have gone from something barely noticed and rarely criticized to a key competitive differentiator for fund companies.

But because some costs borne by fund companies are relatively constant year to year - such as administrative, legal and marketing - there might be some pressure for expense ratios to rise this year. You see, the expense ratio is calculated by dividing the costs by the total amount of assets held by the fund company, which are generally lower by 20% or more across the board in 2009.

This is where the wonderful force of competition will rear its head, as fund companies face losing customers if their expense ratios tick up this year and going forward. As a result, companies may have to permanently trim some fixed costs or temporarily accept lower profit margins to not only gain new customers, but keep their existing ones.

Charles Schwab has cast an impressive first stone into the competitive mix, recently lowering the expense ratio on their S&P 500 Index fund to a barely-visible 9 basis points. Schwab has also lowered the minimum investment size to just $100. By comparison, the industry torchbearer for low fees, Vanguard, charges 15 basis points for its flagship S&P index fund while requiring a $3000 initial investment.

Supreme Court Getting Involved
Another force that may push fund fees lower in the future comes from the highest court in the land. The Supreme Court is reviewing its first case against the mutual fund industry in over 20 years, examining why a prominent mutual fund company charges so much more to individual investors than to institutional (read: big money) investors.

Even if the fund company wins this particular case, the precedent may be set for mutual fund companies to avoid the nasty glare of regulators and high courts by keeping the fees of retail investors in check.

The Bottom Line
Whether you're looking to get back into stock mutual funds or still healing from prior injuries, always remember that annual fees are one of the bigger determinants of long-term returns. Over the long run, those tiny basis points add up, so seek out companies that have taken a hard line on costs and avoid funds with sales charges – in this market environment, there's just too much selection in no-load and index funds to pay up. (For more reading, check out Stop Paying High Mutual Fund Fees.)

Follow us on Twitter

Related Articles
  1. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  2. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  3. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Agency Bond

    Find out about the iShares Agency Bond exchange-traded fund, and explore detailed analysis of the ETF that tracks U.S. government agency securities.
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Low Volatility

    Find out about the PowerShares S&P 500 Low Volatility ETF, and learn detailed information about this fund that provides exposure to low-volatility stocks.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Bond

    Find out about the Vanguard Intermediate-Term Bond ETF, and delve into detailed analysis of this fund that invests in investment-grade intermediate-term bonds.
  7. Professionals

    Index or Target Dates in 401(k)s: Which is Better?

    A common question is whether or not plan participants should choose index or target date funds in a 401(k). The answer depends on different scenarios.
  8. Active Trading Fundamentals

    Arbitrage Pricing Theory: It's Not Just Fancy Math

    What are the main ideas behind arbitrage pricing theory? We provide a simple explanation of the model and how to use it.
  9. Investing

    6 Reasons Why Every Investor Should Consider ETFs

    Once you understand the benefits of ETFs, you’ll see how they could be an exciting and smart way to help meet your financial goals. Here some key facts.
  10. Term

    What's an Investment Advisor?

    An investment or financial advisor makes investment recommendations and analyzes securities.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  4. Security

    A financial instrument that represents an ownership position ...
  5. Series 6

    A securities license entitling the holder to register as a limited ...
  6. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth ...
RELATED FAQS
  1. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  2. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  3. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  4. What percentage of a diversified portfolio should large cap stocks comprise?

    The percentage of a diversified investment portfolio that should consist of large-cap stocks depends on an individual investor's ... Read Full Answer >>
  5. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
  6. Why should an investor include an allocation to the telecommunications sector in ...

    An investor should include an allocation to the telecommunications sector in his portfolio, because telecom offers an investor ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!