Faster than nearly anyone thought possible just a few months ago, Americans have jumped back into the market in a bid to rebound from the drubbing they took last year. And while good stock picking and smart bond selection are always important, savvy investors say one basic investment tenet is more vital than ever: Keep costs low.
When the stock market was logging double-digit gains year after year, most investors didn't think twice about how much their mutual fund company charged them-and hardly made a peep if those expenses rose. But with investors still smarting from last year's crash, even with the recent rebound, and experts cautioning not to expect a return to the old highs any time soon, the hunt for lower fees has become a crucial part of a sound investment strategy. "The lower your fund cost, the faster you are likely to recoup the past year's losses," says Russel Kinnel, director of mutual fund research at Morningstar.
One of the ironies of the fund industry is that expenses often increase after a period of lousy performance, as companies make up for dwindling fund assets. It's not surprising then that expenses are expected to reverse what has been a downward trend since 2003. Morningstar estimates that average fund fees could rise about 6 percent this year. That might not seem like much, but costs can add up over time. Assume, for example, that a retiree has a $200,000 nest egg in one fund, growing 8 percent a year, and wants to withdraw 4 percent each year for the next 30 years. If the fund charges the industry's average annual fee — about 1.5 percent — the retiree can withdraw about $9,600 a year. But with a fund earning the same return but charging only 0.2 percent, the retiree can withdraw $11,300 a year.
Of course, higher fees can be worth the price if they come with top-notch performance. "What's important is how much the fund pays you in the end," says Adam Bold, founder of the Mutual Fund Store, an investment advisory firm. At the same time, experts say that low fees often mean better long-term results. The lowest-cost large-company stock funds, for example, returned an annualized average of 0.16 percent over the past decade, while the costliest lost 1.64 percent, according to fund researcher Lipper. The difference was even starker for small-company stock funds, with the cheapest returning an average 5.5 percent a year over the past decade, compared with a 1.6 percent return for the most expensive group.
Some experts believe that the financial crisis has convinced people to make lower-cost funds more of a priority. Vanguard reported inflows of more than $69 billion through August, with two-thirds of it going into its low-cost index-related products. Others are climbing onto the low-cost bandwagon. Putnam Investments lowered fees on some funds and linked other funds' expenses to performance. Charles Schwab has cut fees on a range of funds, including many index products. Some firms charge much lower fees to customers with, say, $100,000 to invest, but individuals also can choose a financial planner who pools together clients' money to snag the lower costs. Morningstar's Kinnel says, in general, just picking funds with the lowest expenses builds in a margin of safety: "Even if they raise their fees a bit, they are still among the cheapest."
These mutual funds combine lower-than-average expenses with strong performance.
Assets: $386 million | Expenses: $78 per $10,000
Run by the same veteran team that manages highly regarded Vanguard Primecap, this is one of the cheaper actively managed stock funds. The managers' contrarian approach and ability to pick stocks of any size has led to impressive returns, putting the fund in the top percentile of midcap growth funds over the past year.
Assets: $2.3 billion | Expenses: $36 per $10,000
The fund's managers focus on firms with the ability to boost payouts, which means the fund's holdings are chock-full of steady cash-flow generators that typically hold up better in volatile periods. The fund ranks in the top 5 percent of its category over the past three years, according to Morningstar.
Assets: $3.2 billion | Expenses: $112 per $10,000
Expenses are typically higher in emerging-market funds, but Pacific Tiger stands out as one of the cheapest options. The fund is one of a handful that regularly invests in smaller firms in emerging markets-an area where many strategists still see greater potential gains.
Assets: $10.3 billion | Expenses: $44 per $10,000
This bond fund has navigated well through most market environments, landing in the top 1 or 2 percent of its bond peers over both the short term and the long haul by investing mostly in mortgage-backed securities. It also recently slashed its fees.
Data: Morningstar
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