Metrics such as price/earnings ratio and dividend yield on the S&P 500 index, a commonly used proxy for the U.S. stock market, are hardly at bargain levels. This has lead several market pundits to predict single digit annual returns for domestic mutual funds over the next decade.
While pursuing the search for the best mutual fund, some mutual fund investors tend to focus exclusively on fees and expense ratios. The rationale is that by choosing
mutual funds with low fees, investors will have more of their capital invested. Also, no load mutual funds with low expense ratios will pass on more of the returns
they earn to their shareholders.
Is shopping for the lowest fees and expense ratios a smart way to select mutual funds? Not always. The answer depends on the type of mutual fund you are evaluating,
the time you can devote to evaluating and managing your mutual funds investments, and the type of cost incurred.
Investing in the Best No Load Index Mutual Funds.
If you believe markets are generally efficient and prefer to invest in an index mutual fund to achieve an index-like return, shopping for the best index mutual
fund based on low fees and a low expense ratio makes good sense. The portfolio manager of an index mutual fund endeavors to invest the fund’s assets to track the
index as closely and cost-effectively as possible. Larger index funds have an advantage in that they can spread their operating costs over a larger asset base.
Some of the interesting index mutual fund options currently available include no load index mutual funds like E*Trade S&P 500 Index Fund (Nasdaq: ETSPX),
Fidelity Spartan 500 Index Fund (Nasdaq: FSMKX), and Vanguard 500 Index Fund (Nasdaq: VFINX) with expense ratios of 0.09%, 0.10%, and 0.18%, respectively.
Investing in Actively Managed Mutual Funds and Strategies.
Mutual fund fees and expenses are just one of several important factors to consider if you believe portfolio managers can add value and out-perform the index
through active management. The portfolio manager’s ability and investing style are just as important. Therefore, seeking out the best mutual fund based on just low
fees and a low expense ratio may not always be the right approach. It may just be a case of being ‘penny-wise and pound-foolish’.
Legendary investor Peter Lynch, who managed the Fidelity Magellan Fund (Nasdaq: FMAGX) from 1977 to 1990, achieved returns well in excess of the market averages
even after accounting for the fund’s fees and expenses.
So too has Bill Miller who currently manages the Legg Mason Value Trust (Nasdaq: LMVTX). Even after accounting for its relatively high 1.7% expense ratio, this
no load mutual fund has achieved compound annual returns of 18.6% for the 10 year period ending in 2004, well in excess of 12.0% for the
Vanguard 500 Index mutual fund.
Ensure Your Mutual Fund Puts Your Interest First.
Whether you prefer to index or take an active approach to managing your investments, ensuring that your mutual fund is putting your interests first is good
Mutual funds charge different types of fees. By looking at some key factors pertaining to fees, you can get a sense of whether the mutual fund puts your interests
first or merely seeks to line the mutual fund company’s pockets.
Serving the Interests of Long-Term Shareholders. Some mutual funds impose short-term trading fees to discourage frequent trading of mutual fund shares. Frequent
trading disrupts efficient management of the mutual fund and increases operating expenses. A short-term trading fee can therefore actually be beneficial to long-term
shareholders if the fee is rightly treated by the mutual fund company.
Fidelity Spartan Total Market Index Fund (Nasdaq: FSTMX), for example, follows the practice of returning short-term trading fees collected on shares held less than
90 days to the mutual fund itself rather than passing on the benefit to the mutual fund company. By having this short-term trading fee structure, this no load mutual
fund seeks to contain its operating expenses. Such fees are therefore aligned with the interests of long-term shareholders of this mutual fund.