The Bad Market's Silver Lining: Lower Mutual Fund Fees

By Ryan Barnes | August 04, 2009 AAA
The Bad Market's Silver Lining: Lower Mutual Fund Fees

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.)

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