Q. How does one compare mutual fund expenses with organizations that invest directly in stocks? An independent financial organization is attempting to convince me that mutual fund costs to the investor are higher than independent investors. They say that costs are significantly higher than the stated expense ratio. The other costs include things like trading commissions, trading costs, etc.

As a buyer of mutual funds, are some of these costs hidden? Are mutual fund companies like Vanguard not telling investors all the costs or are the independent companies marketing in a fraudulent manner? They are claiming their costs will be 1.5 to 1.75 percent versus 3 to 5 percent for a mutual fund.

---D.M., by e-mail

  

A. Until I see research to the contrary, these assertions are just slippery marketing. Let me walk you through a direct comparison of typical managed/wrap account fees with mutual fund expenses.

The expense ratio of a mutual fund includes the management fee, trustee and custody fees, printing, postage, and other out-of-pocket expenses for operating the fund. As everyone knows, the expense ratios of mutual funds vary widely.

While the average expense ratio for all domestic equity funds is 1.42 percent a year, for instance, those with at least $500 million in assets average 1.06 percent and those with at least $2 billion in assets average only 0.87 percent a year. Graded by size, expense ratios for fixed income funds tend to be even lower --- 1.12 percent, 0.87 percent, and 0.69 percent, respectively.

The cost of trading commissions is not included in the expense ratio of mutual funds. That expense is separately listed in the prospectus. While the dollar figure may look large, it is generally tiny when measured as a percentage of assets under management.

The trading costs of mutual funds (and other institutional investors) are another matter. A variety of studies have shown that these can loom large when mutual funds (or other large buyers) want to buy or sell large blocks of stock. These costs are invisible but real. An actively traded fund can have total annual costs well over 3 percent due to trading costs.

That said, a managed account would have the same invisible costs as a mutual fund with comparable trading volume. As a result, the best way to measure relative cost is to compare the expense ratio of a mutual fund with the management fee for the managed account. These fees run upwards from 1.5 percent, with many firms striving for a yield on your money of at least 2.0 percent, according to Cerrulli Associates in Boston.

Bottom line, unless the fees are carefully negotiated, managed accounts are significantly more expensive mutual funds.

Let's consider an example: suppose you had $1 million to invest. You could take it to a retail broker and have it invested across a variety of funds in the American Funds family. Because your investment was large there would be no front-end commission. Invested in, say, Investment Company of America, it would cost 0.56 percent a year and would have done better than the S&P 500 Index over the last 15 years.

Some million-dollar investors, however, may not learn about this fund because the broker will make more money by selling a managed account.

  

Q. Most financial advisors recommend adjusting the volatility level of a person's financial portfolio as one nears retirement. Do you foresee a substantial impact on the stock market when the multitude of baby boomers that follow this advice start reallocating their portfolios out of stock positions into more conservative investments such as bonds? If so, when can we expect to start seeing this occurrence?

---L.A., Allen, TX

  

A. Some would argue that the shift you mention is already in motion--- in both 401k accounts and retail mutual fund accounts people have been reducing their commitment to equities and increasing their commitment to fixed income. In addition, many people are seeking alternatives to bond funds that may offer some inflation protection. In the 12 months ending April 12th, for instance, the top performing domestic stock fund category was "real estate", up an average of 29.03 percent, according to Morningstar.