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Mutual Fund Fees: Here’s What Matters

Investors will probably see good news in Morningstar Inc.’s annual report showing that the fees charged by actively managed mutual funds continue to come down.

The truth is that focusing on fees alone misses the point. What matters is a fund’s after-fee return. There are always fund managers who excel at picking stocks and can deliver strong after-fee returns to investors year after year, justifying the high fees required to pay them. The early years of Fidelity’s Magellan fund is the classic example.

The trick is finding that clever manager, which requires a combination of luck and the skill and inclination to compare numerous investment options. One thing making this task a little easier is the mutual fund industry practice of reporting returns, net of fees. But the research shows that stock funds that consistently outperform their benchmarks are few and far between – and finding them would be particularly challenging for 401(k) investors who already struggle with basic decisions.

Morningstar’s fee report indicates investors might be getting the message.  In 2015 and 2016, they pulled a total of $627 billion out of the group of actively managed funds charging the highest fees. During the same two years, they funneled $429 billion of new money into lower-fee index funds.

Yes, active funds’ average fee (called the expense ratio, in a prospectus) declined last year to 0.75 percent – or three-quarters of 1 percent – from 0.78 percent in 2015. This continued a downward trend: fees averaged 1 percent in the early 2000s.

But compare this with 0.17 percent for index funds. In contrast to actively managed funds, passive index funds aren’t set up to beat a market benchmark: their goal is to simply mimic the performance of a specific market index, whether it’s the Standard & Poor’s 500 or a Bloomberg Barclay’s bond index.

(Morningstar’s fee averages are weighted to reflect the dollars of assets in each mutual fund; this better reflects how much investors are actually paying than does a simple average of fees.)

401(k) investors’ best bet for maximizing their after-fee returns, retirement experts say, is passive index funds or exchange-traded funds, which also charge lower fees.  Nothing in Morningstar’s report indicates that should change.

Squared Away writer Kim Blanton invites you to follow us on Twitter @SquaredAwayBC. To stay current on our blog, please join our free email list. You’ll receive just one email each week – with links to the two new posts for that week – when you sign up here

3 Responses to Mutual Fund Fees: Here’s What Matters

  1. Kim,

    You are correct that in your statement 401(k) investors’ best bet for maximizing their after-fee returns, retirement experts say, is passive index funds or exchange-traded funds, which charge lower fees.

    The other problem for 401(k) investors is they are not investment professionals and most will not take the time to research mutual funds and their fees.

    401(k) investors need managed accounts using the lowest cost of all investment options ETFs. Investors are moving record amount of taxable and IRA assets to ETF managed portfolios as Morningstar reports in ETF Managed Portfolios Landscape Reports.

    401(k) investors should have the same opportunity to hire ETF investment managers to manage their retirement accounts as there are doing with their IRA and taxable portfolios.

  2. Tim Maurer says:

    I really enjoy the blog, but I do feel I need to address a concern with this post:

    It seems that with overwhelming evidence that the vast majority of active managers don’t add value, nearly the whole of academia has landed on the opinion that attempts to hunt and peck for the active manager that *might but likely won’t beat the market* is ill advised (whether you’re an Average Joe OR a sophisticated investor).

  3. Chris Carosa says:

    Reader’s might be interested in this articles on the topic:

    A 401k Must Read: Mutual Fund Expense Ratio Myth Busted (http://fiduciarynews.com/2012/10/a-401k-must-read-mutual-fund-expense-ratio-myth-busted/)

    Using actual Morningstar data, it shows where mutual fund expense ratios are relevant and where they are not.

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