You're an astute investor in mutual funds, and year after year you pat yourself on the back for good judgment. But are you up on the numbers-crunching game that affects your quarter-to-quarter returns? Remember, no mutual fund, be it a dog or a dazzler, gives shareholders a free ride. So if you haven't taken the time to examine those pesky things called "expense ratios" - you should. Here's why: For a fund averaging an 8% annual return, "roughly 20% of your potential profit pays for fees and expenses," says Don Phillips, publisher of the Chicago-based Morningstar Mutual Funds. And ff returns dip further into the single digits - as some funds pros are predicting over the next three to five years - even more of your money stands to got tweaked by fees. Says Phillips: "We're looking at a situation where expenses could triple in impact compared with the last decade."
In the first six months of 1993 alone, investors poured a record $116 billion into mutual funds, making the industry one of the richest and most profitable in the country. Much of that wealth, though, gets skimmed right off the top of investor earnings. To got an idea of how fund investors get pinched even in good times, consider how in 1991, one of the landmark years in fund performance, profit margins at some of the biggies - including Fidelity and Seligman - ballooned from 27% to 38%. This is sobering stuff, given that you pay regardless of whether your fund is a winner or loser.
So, in seeking out the best mutual fund for your objectives, you'll need to focus not only on performance and risk - but cost, too. Just how much should you pay? These days, the average annual "expense ratio" - which includes charges for management administration, and other "agony" fees, as Morningstar editor John Rekenthaler calls them - hovers at about 1.50% for equity funds. Steer clear of anything higher, says Rekenthaler, since "it's hard to justify big fees with so many super funds in every category." What about funds that say their uber-management team is worth more? That's bunk. Study after study has revealed that funds with high fees - including loads and expense ratios - perform no better than those with lower costs.
As for bond funds, however, "there's a definite correlation between expenses and performance," explains Ron Roge, a certified financial planner in Centereach, New York. That's because a bond is almost like a commodity - there's not too much a manager can do to add value to it...