What does it cost you every year to own a mutual fund?
It depends on what kind of fund you own.
The latest survey by the Investment Company Institute says the average shareholder ownership cost of a stock mutual fund is 1.49 percent annually of an individual's investment. That average includes not only the expense for running the fund but also sales commissions and marketing fees.
And, because it includes sales loads, that 1.49 percent number is misleading if you buy only no-load funds that don't have commissions or 12b-1 fees, or if you buy only load funds. If you buy both, it could be relevant, but it is an average, not a number you can expect to pay.
For many people, the important numbers are the real expense ratios and 12b-1 marketing and distribution fees, which directly affect fund performance because they come off the top.
Simply put, if the shares of two funds perform identically but one fund has much lower expenses, its annual return will be higher. The longer that goes on, the larger the gap between the two.
One reason for the success of Vanguard's Standard & Poor's 500 index fund, for example, is that its expense ratio is a full percentage point below the average for no-load funds and more than 1.5 percent below the average for some load funds, a huge advantage over time.
But the main reason the ownership-cost numbers have declined is that more people are buying no-load funds, and, since 1980, sales commissions have fallen considerably. In addition, the lower costs of buying funds in a 401(k) helped drop the average.
If you own only no-load funds or load funds, there is a large difference in your returns, based on those averages. Loads' costs are more than double no-loads' costs. In 1997, the last year of the survey, the average ownership cost of an equity load fund, including expenses, was 2.11 percent, while the average cost of a no-load fund was 0.89 percent -- a 1.22 percentage point difference.
That 1.22 point difference can mean a lot of money to you. Accounting for the difference, a $5,000 investment in a no-load fund earning 10 percent a year would grow to $8,052 after five years. A similar investment in a load fund would be worth $7,615, a $437 difference. That doesn't seem like much, but it is $4,370 on a $50,000 portfolio and $8,740 on a $100,000 investment.
If you are paying that difference, are you getting what you paid for: information and advice from the broker or the financial planner who sold you that fund? If you are getting nothing but a bill for the commission, maybe you need to rethink what you are buying or from whom you are buying it.
The study found that the average cost of owning a fund dropped from 2.25 percent in 1980 to 1.49 percent in 1997, but that is averaging load and no-load funds. One major reason for the 33.8-percent drop in average costs was the growth of no-load fund sales since 1980, said John Rea, chief economist for the ICI.
No-load fund assets account for more than 46 percent of all fund assets, according to ICI numbers, and they're rising fast. The ICI reported that 57.5 percent of all new sales for the first 10 months of this year were for no-load funds.
"If people tend to buy a lot of load funds in a year, with their expenses and loads, then the average will be higher," Rea said.
But they didn't. Basically, investors concentrated on buying and holding lower cost -- no-load -- funds from 1980 to 1997, the report said.
Rea accounted for commissions by spreading out the cost based on how long investors hold funds. You don't want to see the formula.
Oddly, the costs of owning a load fund dropped more than no-load funds, from 3.02 percent in 1980 to 2.11 in 1997 -- a drop of more than 30 percent -- while the cost of owning no-load funds rose 14 percent, from 0.78 percent to 0.89 percent.
Major reductions in commissions since 1980 are an important reason for the decline in equity fund costs. Commissions used to be 8.5 percent, but now average 4.7 percent, according to CDA/Weisneberger of Rockville, Md.
While sales commissions have fallen, expense ratios haven't shrunk much.
Fees that eat into returns seem to matter more to investors in a falling stock market than a rising one. And the fund industry dodged a bullet with the market's swift rebound this fall.
Pub Date: 12/20/98