Mutual funds offer immediate diversification and typically give you the peace of mind that at least someone is paying attention to where your money sits. But for these benefits, you must pay some fees. Due to a variety of factors, these fees are now lower than ever, and represent the changing landscape of how America is investing in a low-interest-rate world.
The Investment Company Institute's annual fact book (link opens PDF file) gives a detailed overview of the mutual fund industry. One of the most telling trends in the report is the decline in expenses over the years:
The cost to invest in equity funds, bond funds, and hybrid funds, which invest in both equities and bonds, has fallen to some of the lowest levels in years. Over the past decade, the average expense to invest in an equity fund fell from 100 basis points, or $1 per $100 in 2002, to 77 basis points last year.
The report lists many reasons for this trend. First, even as the amount of assets in a fund increase, the fixed expenses of running the fund remain the same, so usually the expense ratio falls. Second, investors now prefer no-load funds as opposed to front-end or back-end load funds, for which investors pay a fee with the initial purchase or sale of a fund. The average front-end sales load percentage for equity funds have fallen from 3.9% in 1990 to 1% today. Third, economies of scale have also helped reduce costs as the number of households that own mutual funds has increased from 23 million in 1990 to more than 53 million last year.
Finally, the amount of competition has kept a downward pressure on fees. The number of ETFs over the past decade has exploded:
WisdomTree (NASDAQ: WETF ) , the fifth-largest ETF provider, has grown its average assets under management from less than $1 billion in 2006 to more than $23 billion this year, with an average ETF fee of 0.53%. The low-cost leader, Vanguard, keeps putting the pressure on competitors with extremely low expense ratios. For the Vanguard Total Stock Market ETF (NYSEMKT: VTI ) , the annual fee amounts to a paltry 0.05%.
With interest rates and treasury bond yields so low, investors are scrimping and saving for each basis point, and flocking toward lower-fee options. They are also less willing to pay load fees, traditionally paid to advisors for the assistance of finding and purchasing a fund. Retail investors, empowered by online brokerages, have less of a need for this professional assistance, and are helping fuel the growth of ETFs as they construct their own portfolios. Market forces are moving in favor of investors, as one of the key differentiators of these funds is expense ratios.