Fees deduct from returns
NEW YORK — In a review of fees charged by stock mutual funds, Standard & Poor’s found that those with lower-than-average expense ratios consistently outperformed their more expensive peers over time.
S&P, a provider of independent investment research, ratings and indexes, maintains a database of more than 3,000 different mutual fund portfolios. In its second annual study of performance and fees, it found that funds with lower expenses outperformed their pricier counterparts in eight of nine investment styles.
For the second year in a row, the only place investors got an edge by paying more was in the mid-cap blend category, where funds with higher expenses did better over five- and 10-year periods than those with lower expenses. S&P researchers attributed this to the recent success of small-cap stocks, which were available to many mid-cap blend managers.
“The mid-cap blend is the ultimate non-style,” said Phil Edwards, managing director of S&P’s investment services department. “They can reach up or reach down, and the ones that reached up into large caps suffered, and the ones that reached down into the small caps did well. In that one sector, the higher expenses won.”
Despite this anomaly, the study underscores something professional investors have known for a long time: Paying more doesn’t necessarily get you a better deal on Wall Street.
“The philosophy that you get what you pay for should not be applied to mutual fund selection,” said Eric Tyson, author of the guidebook, “Investing for Dummies.”
If you think about what it takes to be a successful mutual fund company, Tyson said, you have to consider the economy of scale: As a fund manages more money, it spreads its fixed expenses over a larger set of assets.
“That means you should be able to buy better fund management at a lower cost,” Tyson said.
Regardless of how many assets they hold, large-cap funds generally charge the lowest expenses, as larger stocks are easier to trade and the issues that affect them are usually well-known. Small-cap stocks are less liquid and often require more research on the part of the fund manager, so paying more for active management in that category has traditionally made sense.
The average expense ratio for large-cap funds tracked by S&P is about 1.16 percent. For mid-cap funds it’s about 1.13 percent, and for small-cap funds it’s about 1.35. The average expense ratio for bond funds is about 1 percent. If you own a passively managed index fund, the expenses are even lower — perhaps 0.25 to 0.30 percent.
If you’re not sure what you’re paying, you can go to the fund sponsor’s Web site and look for the prospectus, which typically includes a table with the expenses, and whatever loads — sales commission paid to brokers — that apply.
For math-phobic investors who don’t take the time to calculate the costs, high expenses can take a serious bite out of mutual fund returns over time. Part of the problem, Edwards said, is that fees are expressed in percentage rather than dollars and cents. The fact that they are costs that will be incurred in the future may also make them seem less ominous.