Of all the factors that affect mutual fund performance, expenses consistently seem to have the biggest impact. For investors it’s very good news that the amount fund companies are charging is steadily trending downward. According to the most recent fee study by Morningstar, the average expense ratio for U.S. stock funds – if weighted based on the amount of invested assets – was 0.64 in 2014. That’s a significant decline from 0.76 back in 2009.    

And as a Wall Street Journal analysis revealed earlier this week, the number of ultra-low-cost funds is growing particularly fast. Fund giants BlackRock and Charles Schwab, for example, recently slashed the expense ratio on ETFs​ that mimic the broad U.S. equity market to 0.03. Just how cheap is that? For every $10,000 that you invest in these funds, you’re only being charged $3 each year.

The piece noted that the number of mutual funds and ETFs with fees of "$10 or less per $10,000 invested" now exceeds 100. Just six years ago there were 40 that could make such a claim.        

Figure 1. As this chart shows, expense ratios have been dropping across the board in recent years. However, passive funds remain significantly cheaper than actively traded ones. (For more, see Passively Managed vs. Actively Managed Mutual Funds: Which Is Better?)

Source: Morningstar 2015 Fee Study 

The expense ratio represents the amount investors are charged for management, marketing and operating functions. It reflects the percentage of a fund’s net assets that are deducted on an annualized basis. However, the ratio does not include the sales charges, or “loads,” that some funds assess.

The Flight to Low-Fee Funds

A number of factors seem to have converged over the past few years to drive prices south. The trend toward lower fees began back in 2003, according to Morningstar. That happens to be around the time when ETFs started taking off, bringing attention to low-cost investing options. Passive funds, which imitate stock and bond indices, have been on a tear ever since. Index funds and ETFs now represent 28% of fund assets in the U.S., up from 13% in 2004.             

There are also other causes. Some advisors have migrated to a fee-based approach rather than charging commissions. As a result they have less incentive to seek out expensive products. On top of that roughly half of funds have fee breakpoints – that is they charge less when their assets under management reach a certain level. After several years of a bear market a lot of those funds have met their pre-established threshold.

As the Wall Street Journal article points out, the Fed’s low-interest-rate policies have certainly aided the downward trend. When investors see meager bond yields it’s harder for investment companies to hide large expense ratios. 

Good for Investors?

With most consumer goods you get what you pay for. However, generally speaking that’s not true of mutual funds. While some actively traded funds with higher fees do very well, most lag behind their more affordable competitors.

That’s consistently the case with virtually every asset class. 2015 marked the sixth year in a row in which fewer than half of money managers beat their benchmark. So for a lot of individuals moving to low-fee index funds and ETFs doesn’t mean forgoing returns – it often means the opposite. (For more, see Mutual Fund or ETF: Which Is Right for You?)

Some industry insiders do suggest that there’s reason for caution regarding the recent dive in fund costs. They say such funds are a way for companies to attract new customers to whom they can later sell higher-priced products. All the more reason, then, for investors to research fees – including sales charges – before putting their money into a fund. Fortunately, that’s easier to do than ever before; every major investment company has a website with detailed information on each product it offers.

Fund Companies Thriving

To date it doesn’t appear that mutual fund companies have been hurt by lower expense ratios: Morningstar estimates that fee revenue reached $88 billion in 2014, an all-time high. Ten years earlier the industry was bringing in around $50 billion from management fees. 

Why the uptick in receipts? Basically, it’s because the value of assets under management has more than made up for any reduction in fee percentages. Two factors in particular have boosted those assets. One is a strong influx of new cash into the fund market.

Figure 2. Some of the largest mutual fund companies, including Vanguard, Fidelity Investments and American Funds, also offer some of the lowest expense ratios.

Source: Morningstar 2015 Fee Study

The other reason is a sustained bull market – notwithstanding the volatility in recent weeks – that has pushed up the price of their underlying stocks. So despite taking a smaller slice of the pie, the industry is still getting a significant amount of revenue from this particular source.

The Bottom Line

The recent wave of low-cost mutual funds and ETFs is a boon for investors, most of whom will see greater long-term returns as a result. Just make sure that your fund provider isn’t offering cheap products to get you in the door only to sell you higher-priced offerings down the road.

 

 

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