A few months ago in USA Today, John Waggoner made some excellent points about mutual funds. He advised us all to look for mutual funds with low costs, demonstrating how seemingly not-so-significant annual costs and fees can eat up big chunks of your nest egg.

Here are some of his points:

Let's consider two funds. BigExpensiveFund charges 1.5% a year in expenses. LessExpensiveFund charges 1%. You invest $50,000 in each. We'll assume you earn 7% a year in each fund. Let's see how the two funds compare. We'll use the SEC's mutual fund expense analyzer, the latest version of which can be got at www.sec.gov. After 10 years, BigExpensiveFund has cost you $13,797 in fees and forgone earnings on those fees. LessExpensiveFund: $9,405. That's a $4,392 savings. The savings can be even more dramatic in a bond or money market fund. The average money fund yields 3.63%. If you pay 1% in annual fees, you're giving back more than 20% of your yield to the fund company.

Where to find low fees
Waggoner offered tips on where to find low fees in the mutual fund world, listing these kinds of funds:

  • Index funds. I fully agree here. Though some index funds are inexplicably costly, many are bargains. The Vanguard 500 Index fund's (FUND:VFINX) expense ratio is a mere 0.18%, versus 1.5% for the typical stock fund. With an annual turnover of 7%, a minimum initial investment of $3,000, a dividend yield recently around 1.7%, and top holdings of General Electric (NYSE:GE), ExxonMobil (NYSE:XOM), Citigroup (NYSE:C), Microsoft (NASDAQ:MSFT), and Procter & Gamble (NYSE:PG), it's a compelling consideration.
  • No-load funds. I can't quibble here, either. With so many terrific no-load funds available, why voluntarily sign up for a load fund and pay what is essentially a one-time sales fee of up to 8.5%? Actually, permit me to quibble a bit here, noting that here and there you'll find some funds that can still be worth investing in despite their loads -- especially if the loads are on the low side. Additionally, many no-load funds can be stinkers and can levy plenty of other excessive fees on shareholders.
  • Big funds. Here's where I take issue. Waggoner said: "It doesn't take 10 times as much money to run a $1 billion fund as it does to run a $100 million fund. Most fund companies with a bit of conscience reduce fees as a fund gets larger." He's correct on these points, but note that many fund companies with even greater consciences actually close their doors when they grow very large. That's because the larger a fund gets, the harder it can be for managers to find enough compelling places to invest the ever-increasing sums of money entrusted to them. That's also why it can backfire if you find a big fund with low fees -- the fees may be low, but performance may be decreasing.

Turnover, too
Another item worth noting is turnover in a fund. This figure reflects how much buying and selling a fund does. The greater such activity, the costlier it is to shareholders, who ultimately pay the commissions on all the trading.

When you evaluate a fund, look at its turnover ratio. The typical stock fund's turnover ratio is roughly around 100%, but many great funds sport ratios much lower. Index funds, of course, will have drastically lower turnovers, since their holdings simply reflect the contents of a given index, which usually don't change too often.

In our Motley Fool Champion Funds newsletter service, editor/analyst Shannon Zimmerman smiles approvingly at funds with not only low fees, but also low turnover. In a recent issue, for example, he recommended a fund with a turnover ratio of just 32% and an expense ratio of 0.89%. Some other recently recommended funds sported turnovers of just 21% and 15%. (Perhaps surprisingly, though, his latest recommendation has a turnover rate of 282%, demonstrating that sometimes high turnover can be worth it -- indeed, this fund's three-year average gain is 40% and its five-year average is 26%.)

Some good ideas
Waggoner offered some final words of advice: "You can save even more by asking about discounts for larger investments. The Growth Fund of America's commission falls to 5% from 5.75% if you invest $25,000. . The NASD has an online tool that can help you get lower commissions: www.nasd.com."

Another good place to find above-average funds is via a trustworthy mutual fund recommendation service. Permit me to offer an admittedly not-unbiased recommendation. One place to find some terrific ideas is the previously mentioned Motley Fool Champion Funds newsletter. Try it for a month and see which funds Shannon has recommended -- and why. Together, his picks have doubled the market's return (as of the last time I checked), gaining an average of 25% versus 11%. Out of 38 picks over two years, only one is in the red, and by less than 2%. Some 24 picks are up more than 15%, and 13 are up more than 30%, which is darned impressive for mutual funds. Shannon maintains three model portfolios, listing appropriate funds for conservative, moderate, and aggressive investors.

A free trial will also give you:

  • Full access to all past issues, so you can read about each recommendation in detail.

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Microsoft is a Motley Fool Inside Value pick.

Selena Maranjian's favorite discussion boards include Book Club, Eclectic Library, Television Banter, and Card & Board Games. She owns shares of Microsoft and an S&P 500 index fund. For more about Selena, view her bio and her profile. You might also be interested in these books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens . The Motley Fool is Fools writing for Fools.