Americans are slowly but surely taking control of their financial destinies. According to the Investment Company Institute, nearly half of all U.S. households owned mutual funds in 2004, compared with less than 6% in 1980.
What's even better is that, also according to the ICI, "Mutual fund fees and expenses fell to their lowest levels in more than a quarter century during 2005."
More and more Americans are buying mutual funds, and it's costing them less and less to do so. That's great news, but it raises one very important question: Are you overpaying for your investments?
More than nickels and dimes
In most aspects of our economy, price and quality correlate directly. The fancy restaurants cost more. The nice clothes cost more. You pay a premium to drink the finest wines.
With mutual funds, however, it's almost exactly the opposite. As Motley Fool Champion Funds analyst Shannon Zimmerman is fond of saying, "You get what you don't pay for."
That's because a fund's annual fees are debited directly from your account, hurting your performance each year. And in an industry where roughly 75% of actively managed funds underperform the S&P 500 over 10-year periods, high fees are a high hurdle to great returns.
How much is too much?
According to a recent USA Today article, the average stock fund charges a 1.5% expense ratio. For simplicity's sake, let's compare that with a fund that will ding you just 1% on average (the average expense ratio of our Motley Fool Champion Funds picks, incidentally, is 1.02%). If those 50 basis points don't seem like a lot, consider this little exercise:
Let's say you're 22 and fresh out of college. (If you're younger, congratulations -- you've got a lot of great years ahead of you. If you're older than that, then I'm sure you won't mind reliving our glory days with us.) That means you have 43 investing years before you retire at age 65. Let's also say that you have $1,000 each year to contribute to the mutual fund in your retirement account.
Let's run the numbers
If each fund achieves the same 10% return before fees, by the end of your 43 years, the fund with the 1.5% expense ratio will have cost you nearly $70,000 in gains ($480,522 vs. $413,314).
That's if the two funds earn the same. But there's almost no way they'll earn the same return before fees each year -- the cheaper fund should do better because low fees tend to correlate with two other winning traits:
- A shareholder-friendly fund manager.
- A long-tenured fund manager.
The reason low fees correlate with great fund managers is that fees come down as returns and assets under management rise -- at least, they will when there's a shareholder-friendly shop behind the fund. In other words, the more success the fund manager has for you, the less his fund should cost you.
And that's a great deal.
Case in point: The outstanding track record of Ron Muhlenkamp, head honcho at Champion Funds recommendation Muhlenkamp (MUHLX). Despite being able to point to market-thumping 14.5% annualized returns over the past 10 years on the back of contrarian picks such as Centex (NYSE:CTX), Citigroup (NYSE:C), American International Group (NYSE:AIG), Cemex (NYSE:CX), Countrywide Financial (NYSE:CFC), and Allstate (NYSE:ALL), Muhlenkamp cut his fund's expense ratio eight basis points earlier this year.
That kind of performance, tenure, and shareholder-friendliness is the hallmark of a long-haul market beater.
The Foolish bottom line
With more and more Americans using mutual funds to build their wealth, fund fees have only come down. While that's a good long-term trend, it's only good for you if you're not overpaying.
The stock funds in Shannon's Champion Funds service are cheap and, on average, beating the market at large by 8.5 percentage points. To see the list of Champs or to learn more about great managers like Ron Muhlenkamp, click here to join Shannon and his Champion Funds analysts free for 30 days.
Neither Brian Richards nor Tim Hanson own shares of any company mentioned in this article. The Fool's disclosure policy is grilled to perfection.
