Mutual fund fees are sweating under the spotlight lately. Michael Oxley and Richard Baker, members of the House of Representatives Financial Services Committee, have pushed for increased disclosure of how much funds charge investors. Currently, it's difficult for investors to determine how much of their capital is eaten up by administration costs, manager salaries, trading commissions, and incentives to brokers, among other costs.
Investors have one primary gauge of how much a fund will cost: the expense ratio. However, expense ratios don't tell the whole story. John Bogle, founder of the Vanguard family of mutual funds, estimates that the expense ratio might account for as little as half of the true costs of investing in a fund.
For now, though, the expense ratio is all investors have. And a recent study found that investors would collectively save $300 million if they kept their eyes on the expense ratios of just two types of funds.
Investor advocates Fund Democracy and the Consumer Federation of America found that many investors are overpaying for money market funds and index funds. With the help of information from Morningstar, the study found the following:
- 65 money market funds with expense ratios higher than the 0.33% charged by the Vanguard Prime Money Market Fund, the low-cost benchmark. The average expense ratio of these funds was 0.92%, going as high as 1.89%.
- 57 Standard & Poor's 500 index funds with expense ratios higher than the 0.18% charged by the Vanguard 500 Index Fund. The average expense ratio of these funds was 0.82%, going as high as 2.18%.
You should never pay more than necessary for an investment, but overpaying is especially egregious when it comes to money market and index funds. It's like paying four bucks for something at the "Everything's a Dollar" store and tipping the cashier on the way out.
The securities within these funds don't differ much from provider to provider -- after all, the S&P 500 is the same for T. Rowe Price (NASDAQ:TROW) as it is for American Express (NYSE:AXP) -- so keeping costs low is the key to choosing the best-performing fund. As Mercer Bullard, president and founder of Fund Democracy, said: "These funds are essentially fungible. The higher fees provide no additional benefits to shareholders and serve only to reduce investors' returns and fatten fund managers' profits."
For help on picking the best index fund for you, check out our 60-Second Guide. And for guidance on picking the best money market account, visit our Savings Center.
