With the economies of scale created as mutual-fund assets swelled to more than $4 trillion over the past decade, you might think funds would lower the fees they charge investors. Au contraire.
Average expenses charged to stock-fund investors have actually risen, from 1.28 percent to 1.49 percent.The same trend applies to bond funds, whose average expense ratio is 1.05 percent today vs. 0.89 percent a decade ago.
Fund revenues from expenses are huge. For example, Scudder Development, an aggressive-growth fund with below-average returns, generates more than $10 million in fees each year from its 1.24 percent expense ratio. The gigantic Kaufmann fund grossed $116 million last year by paying itself 1.93 percent of its $6 billion in assets.
That higher expenses hurt fund returns is incontrovertible; by definition, expenses nip a percentage of your mutual-fund assets each year. The higher the expense ratio, the harder it is to beat market indexes or category averages.
But it's worse than you might think. We divided the 1,132 long-term-growth funds into two groups: those with expense ratios above the 1.48 percent average for the category and those with ratios below the norm.
On average, those with lower expense ratios returned two percentage points a year more than funds with above-average expenses the past five years.
So if you dropped $10,000 into a higher-expense long-term-growth fund five years ago, you'd have about $1,500 less today than if you'd invested in a lower-expense fund.
The results are the same in virtually every other fund category: Low-expense funds return more, on average, than high-expense funds. The exception is high-quality corporate-bond funds.
Don't count on independent trustees at mutual-fund companies to ratchet down expenses. John Bogle, chairman of the thrifty Vanguard Group of funds, says compensation for directors at the 10 highest-paying fund companies averages $150,000 annually, almost double the average at the 10 best-paying Fortune 500 companies.
That's a strong incentive not to rock the boat, Bogle says. Plus, he says, lowering expenses would have a cataclysmic effect on a fund company's profits.
The only other player with a sword big enough to slay the expense dragon, the Securities and Exchange Commission, so far hasn't focused on expenses.
But you, of course, can. Unless a fund's performance is superior, there's no reason to pay high expenses to own it. When selecting funds, favor those with low expense ratios.