Fund costs come down again, but is it enough?

By Mark Jewell AP Personal Finance Writer BOSTON (AP) -- It's easy to overlook what's important when it comes to saving money. Many people would sooner clip a coupon for shampoo than review the expenses they're paying to invest in mutual funds. Cost is hardly the only consideration because a fund charging above-average fees may generate larger returns than a low-cost fund. But more often than not, any performance edge that a fund manager achieves is erased by the fees that are shaved off investors' returns. The bottom line: Fees matter, especially when it's a product like mutual funds, which most investors will own for decades as they save for retirement. The good news is that costs continue to come down. Fund expenses fell slightly last year, extending a long-term trend, according to an annual update last week from the Investment Company Institute, a trade organization. Yet the findings show there are plenty of areas where the industry could be doing more to reduce the costs that investors pay. Stock fund investors paid an average expense ratio of 0.77 percent last year. In dollar terms, that's $77 shaved from the return earned by a $10,000 investment in a fund. That's down from 0.79 percent in 2011 and 0.83 percent in 2010. Going back further, the progress has been even more impressive. Expenses averaged 1.07 percent in 1993. Those are the ongoing expenses paid out of the fund's assets to cover operating costs, expressed as a percentage of total assets. Each shareholder indirectly pays a proportional share of overall costs via the expense ratio, with the amount paid based on average fund assets over the course of a year. The size of the expense ratio determines how much money an investor earns from a fund's investment returns. To calculate average fees across thousands of funds, the ICI compared each fund's expense ratio with its end-of-the-year asset total. The averages are asset-weighted. That means expenses at funds with large asset totals, and therefore lots of investors, count more toward the averages than expenses at smaller funds. In addition to stock funds, expenses declined at bond funds and mixed-asset funds that invest in stocks and bonds. But it's clear the industry needs to do more to keep investors' costs down. Here are 4 areas meriting special attention: 1. Little Progress for Bond Funds: Average expenses at bond funds slipped to 0.61 percent from 0.62 in 2011, and 0.64 in 2010. Ten years ago, the average was 0.83 percent. Although that's a positive trend, the decreases in recent years have been surprisingly small, says Todd Rosenbluth, a fund analyst with S&P Capital IQ. Go back to 2008, and bond fund expenses averaged the same 0.61 percent that they did last year. Yet since then, bond funds have attracted more than $1 trillion in cash, as anxious investors pulled money out of stock funds and invested in the relative safety of bonds. In fact, assets in bond funds have more than doubled since 2008, to about $3.5 trillion. Yet it's unlikely that costs to manage those funds have doubled. As with many industries, size counts with mutual funds. It doesn't cost twice as much to manage a fund with $2 billion in assets than it does to run a $1 billion fund. The larger the fund's asset total, the larger the revenue from fees. The more profitable a fund is to run, the easier it is for its management company to cut fees without hurting the bottom line. Rosenbluth suspects that one reason that bond fund expenses have declined more slowly than stock fund fees in recent years is that bond funds typically charge less than stock funds. As a result, there's less room for bond funds to reduce fees, without potentially cutting so much that the fund is only marginally profitable. 2. Slowing Rate of Improvement: Last year's 0.02 percentage point decline in the average stock fund expense was just half the size of the 0.04 point decreases in 2011 and 2010. The ICI says it's difficult to make sweeping conclusions about expense trends over a few years because each year's figure is an average that's rounded off. A relatively small difference in expenses from one year to the next can look big or small when it's rounded. One reason progress has been slow is that investors have been withdrawing more cash from U.S. stock funds in recent years than they've deposited into them. With cash flowing out, it's hard to cut fees. Yet that impact would have been greater if not for the market rally that started in early 2009. Investment gains increase the amount of assets in funds, allowing a fund to be run more efficiently. 3. Slow Progress for Managed Funds: A key reason that investors have been pulling cash from managed stock funds in recent years while adding to index funds is the cost differential. Managed stock funds charged an average 0.92 percent last year, or nearly seven times more than the 0.13 percent average for index funds. The gap has been widening in recent years, as costs at index funds have come down more rapidly than fees charged by managed funds. A decade ago, managed stock funds charged an average 1.10 percent. Last year's average is down just 16 percent from 2003. In contrast, the average index fund charges nearly half of what it did in 2003, when the average was 0.25 percent. 4. Many Funds Remain Pricey, Despite Size: The ICI's report doesn't offer specifics on individual funds, but research by S&P Capital IQ identifies several large funds that continue to charge above-average fees, despite the cost-efficiency one might expect. Rosenbluth found 17 funds, most of them stock funds, with more than $5 billion in assets that have expense ratios of at least 1.0 percent. These funds are charging above-average fees, yet rank among the largest 10 percent of funds based on size. "These should be more efficient to run, and they could be sharing some of those benefits to fund shareholders through fee reductions," Rosenbluth says. -------------- Questions? E-mail investorinsight@ap.org. Published: Mon, Apr 15, 2013