FA Yardstick for Mutual Fund Expenses

Whose money is it, anyway?

In case you have forgotten, all that money in mutual funds belongs to you and me. It may be diminished, but what remains is still our money. Unfortunately, that doesn’t mean we get the most reliable benefit from our money— income.

Like the old divorce joke— “She got the mine and I got the shaft.”—the financial services industry gets paid first, but we take the fall when markets collapse.

Here’s a troubling snapshot. The largest category of mutual funds is what Morningstar calls “domestic large cap blend” funds. The Morningstar database indicates 1,768 of these funds with 3-year track records. Average the group and you’ll find they have average net expense ratios of 1.22 percent… and average SEC measured yields of 0.90 percent.

So, the managers get the income— and then some— and we get the risk. Worse, while our dividend income is declining, fund managers are raising their fees. They do this because their income is based on a percentage of our declining assets.

Yes, there are fund categories where the managers don’t take all the income. But the vast majority of investors are over-paying for under-delivered service.

I have been demonstrating a simple reality for 30 years. High cost funds tend to provide lower returns than low cost funds. Like most things probabilistic, this isn’t guaranteed. It’s just probable.

So I’d like to introduce a new measuring tool. Think of it as the Fat Fund Report. Using it, you’ll be able to learn where your fund ranks in costs. You’ll be able to find out if your fund manager is in the least expensive 10, 25 or 50 percent of managers by category. Ditto the other end of the scale, where funds proudly taking more of your money than 90 percent of other funds. You can view the figures and download the pdf by clicking here.

If you own a large blend fund with a net prospectus expense ratio of 1.18 percent or less, you own a fund with below-median expenses. If your fund expenses are 0.82 percent or less, it ranks among the least expensive 25 percent. And if your fund has a net expense ratio of 0.46 percent or less, it ranks in the slimmest 10 percent.

If your fund ratio is greater than 1.57 percent, it is more expensive than 75 percent of comparable funds. It is in the greedy 10 percent if its expense ratio is 2.03 percent or more. Don’t know the expense ratio for your fund? Visit the Morningstar website, type in the name or ticker for your fund, and find the expense ratio in their fund report.

It should be noted that some distribution channels are more expensive than others. The “B” share version of most funds— where an annual charge replaces an up-front load— will generally be found among the 25 percent most expensive funds. So will shares that build in adviser fees as a 12b-1 charge.

So what funds are doing right by investors? One of the largest is American Funds Investment Company of America A shares. This managed fund has an expense ratio of 0.59 percent. It lost 7.13 percent annualized over the last three years. That’s 1.09 percent a year better than the S&P 500 index. Similar figures obtain for American Funds Fundamental Investors A shares (0.61 percent expense ratio, minus 6.43 percent three year annualized return), Vanguard Life Strategy Growth (0.21 percent expense ratio, minus 6.26 percent three year annualized return), and Fidelity Fund (0.55 percent annual expense ratio, minus 6.5 percent three year annualized return).

What about big expensive disappointments?

Davis New York Venture B shares top the list with a net prospectus expense ratio of 1.66 percent and a 3 year annualized loss of 10.02 percent. Oppenheimer Main Street B shares clocked in with a similarly high 1.66 percent net prospectus expense ratio and a 3 year annualized loss of 9.25 percent. Pioneer B shares (2.12 percent expense ratio, 8.95 percent 3 year annualized loss) and Legg Mason Value C shares (1.73 percent expense ratio, 18.91 percent 3 year annualized loss) are two other large and well-known funds that have done poorly for their investors.

How big is the performance gap between the lowest cost and highest cost large blend funds? Averaging the ten percent most expensive and the ten percent least expensive, the parsimonious funds bettered their spendthrift counterparts by an annualized advantage of 1.05 percent over the last three years.

Bull or bear market, costs matter.