Mutual Funds
Recent articles:
• All dividends, all the time, 1/28/2003
• 2 'hot hands' for 2003, 1/21/2003
• 6 traits the best funds share, 1/14/2003
More...
| | Mutual Funds
Could you use $22,207.61?
That's what a seemingly tiny increase in a fund's expenses could cost you. The charges seem minuscule, but they're spiraling upward -- and taking a big chunk out of your investment.
By Timothy Middleton
To the injury of ruined investment portfolios, the mutual fund industry is adding the insult of higher expenses. And whats really insulting is that hordes of individual investors dont seem to mind.
I think investors are a little naive, says Sheridan Titman, professor of finance at the University of Texas. They ignore expenses because they seem so tiny -- less than 1.5% at the typical growth fund. But if youre 42 years old, and youre going to retire in 25 years, compounding 1.5% produces a pretty sizable number.
In the last five years, the average growth fund has boosted its annual expense levy 11.8%, from 1.27% to 1.42%, according to Lipper. And the trend is getting worse. In January, Charles Schwab (SCH, news, msgs) raised the charge it imposes on funds that participate in its popular No Transaction Fee network, or fund supermarket, an imperious 14.3%. (The new rate is 0.4% of new business brought in through the network. It has been .35%.)
Some funds simply pass along that hike to their investors. For instance, one mutual fund that wants into that network, Harbor Capital Appreciation (HACAX), is hiking its expenses an astounding 65% -- as if a gas station had decided to charge $2.50 a gallon instead of $1.50.
It wasnt supposed to be like this. A generation ago, mutual funds charged sales commissions, or loads, approaching 10%. But the growth of no-load funds has dragged that down to about 5.75% for load funds, and nothing for no-loads. I think its pretty clear that people like Vanguard (with its low fees) have had an impact on expenses, says James Cotter, associate finance professor at Wake Forest University.
The never-ending story
But one-time sales commissions are tame compared with charges that never stop. In the 1990s, the Securities and Exchange Commission allowed funds to impose a so-called marketing fee, in addition to their levies for fund management and administration. Called 12b-1 fees, they range from zero at true no-load funds to 1% on some share classes of load funds.
That, says the mutual funds industry, explains the rising average. The most-recent data capture all new share classes that have 12b-1 fees, which are there in place of front-end loads, says John Collins, a spokesman for the Investment Company Institute, the industrys trade association.
Source: Lipper Inc.
Classes B and C of load funds, which bear the heavy 12b-1 fees, have the appearance of being no-loads, and theyve proved highly popular -- and ultimately costly to their shareholders.
According to Lipper, the annual expenses charged by equity funds as a group have risen 8.5% since 1998 to an average of 1.46%. Sector funds have hoisted charges 14.2% to 1.78%.
Price increases continue to sweep the industry like a Great Plains blizzard. One contributor is the fund supermarket, popular with investors because it offers one-stop shopping with choices galore. Schwab is raising to 0.4% from 0.35% the annual charge it levies against mutual fund companies that participate in its NTF network. Fidelity charges 0.35% for its NTF plan and says it has no plans for an increase.
Benefiting from the supermarket
These fund supermarkets have become sales agents for individual funds, buying and selling them in bulk on behalf of their customers. Some fund companies, and in particular small ones like Harbor, benefit enormously from the instant availability the supermarkets deliver.
The thriftiest mutual fund companies, like Vanguard and T. Rowe Price (TROW, news, msgs), however, have always shunned the fund supermarkets because their fees are so extravagant. And with funds, you do not get what you pay for in annual expenses. Premier funds like American Funds Investment Company of America (AIVSX) and Fidelity Growth & Income (FGRIX) almost invariably have low fees 0.57% at American, 0.68% at the Fidelity fund.
The new charges at Harbor throw the issue into high relief. Existing shareholders of Capital Appreciation pay expenses of 0.66% per year, or $660 on an account of $100,000. New shareholders will pay that plus the Schwab charge, for a total of 1.06%, or $1,060.
Shareholders receive absolutely no value for this extra $400, except the convenience of being able to own funds from various sponsors in a single account. That is, I confess, a powerful-enough argument that I have Schwab accounts for exactly this reason.
But the combination of rising costs and lower stock market returns is making me reconsider. When I do the math, I blanch.
Distressing numbers
Take the Harbor fund. It delivered average annual returns over the decade ended Dec. 31 of 9.03%. The fund actually beat the market (and with significantly less risk), but its expenses dragged it down to an annual slippage of 0.31%. Had the expense ratio been what the fund now will charge, it would have lagged by 0.71%.
A 32-year-old investor would have 35 years to retirement. Projecting Harbors 10-year average return into the future, a $10,000 account at the old expense ratio could compound in that time to $189,044.70. At the new ratio, that value would plunge to $166,837.10.
These are real dollars -- $22,207.61 of them -- that investors will surrender if they are willing to pay the higher fee. Thats a steep price to pay for convenience.
My children have Roth IRAs with Vanguard, where they invest strictly in index funds. Vanguard 500 Index (VFINX) returned annual average gains of 9.27% in the last decade, beating 80% of its rivals partly because its expense ratio is so low -- 0.18%.
Two years ago, Congresss General Accounting Office scrutinized fees and blasted the industry for concealing them. But it took no position on whether they were too high.
Turning up the congressional heat
This year, two congressmen, Michael Oxley, R-Ohio, and Richard Baker, R-La., are asking the GAO to do exactly that. Oxley is head of the House Financial Services Committee and Baker chairs its Subcommittee on Capital Markets, and thus are among the industrys regulators.
Simply throwing light on the subject can help pressure the industry to rein in its free-spending ways. But investors dont have to wait on Washington. We can yank our dollars from high-cost funds and fund supermarkets.
Expenses werent much of an issue with individual investors in the late bull market, because returns were in double digits. Most market analysts expect them to be more like 7% in the decade to come. Giving away nearly a point and a half of that is madness.
To save your brain, use our Fund Screener technology to identify high-quality funds with rock-bottom expenses.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
|
