By Scott Burns

This week, thanks to data from Morningstar, we’re taking a look at how low-cost no-load funds stack up against their more expensive competitors. We’re also going to search for a rare bird, load funds that are like inexpensive no load funds.

As it was with load funds, the data shows that the expense ratio of a fund tells us a lot about future performance. High cost funds tend to trail the performance of low cost funds.

Is the advantage certain? No. Nothing in investing is certain. But it is probable and that’s as good as it gets.

Here are some example:

• While domestic large-cap blend funds in the least expensive 10 percent of their group had expense ratios of 0.30 percent or lower, funds in the most expensive 10 percent cost 5 times as much with expense ratios of 1.54 percent. Over the three years ending April 30 the lower cost funds had a return advantage of 3.93 percentage points a year.
• Inexpensive foreign large-cap blend funds cost 0.35 percent or less while their expensive counterparts cost 1.51 percent or more. The performance difference was an annualized 5.91 percentage points.
• Inexpensive diversified emerging-markets funds cost 0.76 percent while their expensive counterparts cost 1.89 percent. The performance difference was an annualized 6.79 percentage points.

The outperformance of lower expense no-load funds wasn’t a slam dunk because there were some notable exceptions. Expensive small-cap value funds, for instance, had a stunning 12.18 percentage points annual return advantage over inexpensive small cap value funds. Similarly, expensive world stock funds had a 3.29 percent annualized return advantage over inexpensive world stock funds. That said, in a large majority of fund categories, picking a low-expense fund over a high-expense fund was a good way to raise the odds of achieving a better performance.

Nothing is permanent so it is very likely that the return differences between high-cost and low-cost funds will change from month-t- month. All we can be certain of is that most of the time, in most categories, the funds with lower expenses will beat the funds with higher expenses. So we need to reverse the adage. Forget “You get what you pay for.” In mutual funds it is, “You get what you don’t pay for.”

Comparing the table for load funds with the same table for no-load funds also leads to a curious observation. Across the board, the average load fund is more expensive than the average no load fund. So even after paying a commission, you’ll be stuck with higher annual expenses if you want selection advice from a broker.

We’re not talking about a small difference here. On average, across all categories, the median load fund costs an additional 0.72 percent a year more than the median no load fund. Viewed another way, load funds that were in the lowest 25 percent for costs would generally rank in the most costly 25 percent among no-load funds. That makes load funds, as a group, pretty expensive and it isn’t being done to benefit you and me.

There are, I think, two ways we can respond to this knowledge. First, we can vow to become independent, do-it-yourself investors. It isn’t that difficult. Since investing in a low-cost no-load index fund is likely to provide you with performance that beats about 70 percent of managed competitors, you have little to lose, and much to gain.

Second, if you really don’t want to be a do-it-yourself investor, you can start to look for a broker who specializes in something really rare— relatively inexpensive load funds. That way, the broker/advisor gets paid, but you maximize the chances that ongoing costs won’t diminish your long term returns.

To search for this fund family I used Morningstar Principia to search for load funds whose expense ratios were close to the bottom 25 percent of expense ratios for all no-load funds. One fund family came up quite consistently.

It is the American Funds group. Here are a few examples.

• The Income Fund of America (A shares) have an expense ratio of 0.61 percent, slightly lower than the 0.70 percent mark for least expensive quartile of no load moderate allocation funds.
• Their Fundamental Investors (A shares) has an expense ratio of 0.64 percent, slightly more expensive than the 0.60 expense ratio for the least expensive quartile of no load large blend funds.

The American Funds New World fund (A shares) has an expense ratio of 1.04 percent, somewhat less than the 1.12 percent for the least expensive quartile of no load emerging markets funds.