Mutual fund expenses can make a difference

November 23, 1994|By ANDREW LECKEY | ANDREW LECKEY,Tribune Media Services Inc.

They just keep rolling along, whether Republicans or Democrats hold majority power, whether interest rates are low or high, whether the stock market is weak or strong.

The expenses associated with a mutual fund remain constant, ** even though the fund's returns fluctuate from year to year. No one notices underlying costs much when markets are booming. Their bite becomes obvious during a difficult and uncertain period such as 1994 when returns are under pressure.

Investors obsessed with total returns often overlook the fact that expenses vary widely among funds. Studies indicate that funds with higher expenses provide total returns no better than those with low expenses, so you're paying just for the sake of paying.

There are a number of components to mutual fund costs. Most investors are aware of front-end "loads" (initial sales charges) or back-end loads (redemption fees for withdrawal during the first few years after purchase). Many investors choose "no-load" funds to save money.

But the ongoing expense ratio of a mutual fund is equally important. It includes annual costs as a percentage of average net assets and usually ranges from 0.50 percent to 1 percent for bond funds and 1 percent to 2 percent for stock funds.

Included in that computation are 12b-1 fees, named for a Securities and Exchange Commission rule that allows funds to recoup advertisingand marketing costs by slapping annual charges on shareholder assets each year. There are also expenses for administrative and management services.

"A lot of billionaires in the mutual fund business made a lot of money at the expense of fund shareholders," declared John Bogle, chairman and chief executive of the $108 billion Vanguard Group, a leader in low expenses. "I'm not suggesting that is criminal, but it is the way the system is."

Among the biggest fund groups, Vanguard has an average expense ratio of 0.29 percent, compared to 0.67 percent for the Franklin Group, 0.79 percent for the American Funds, 0.81 percent for Dreyfus and 0.87 percent for T. Rowe Price. The expense ratio averages 1 percent for both Scudder and IDS, 1.09 percent for Merrill Lynch and 1.13 percent for Fidelity.

Groups dominated by bond funds rather than stock funds have lower average expenses, since investors buy bond funds for yield and a high expense ratio would put a fund at a disadvantage. Index funds, which purchase stocks based on their representation in an index and don't require active management, also feature low expenses.

There are many ways funds can keep down costs.

"Rather than use four-color, slick, glossy paper for our prospectus and shareholder report, we put good information on cheaper paper to help keep expenses low," said James Benham, a manager with the $10 billion Benham Group, which also has a number of low-cost funds.

When choosing between funds with similar performance, determine which has lower expenses.

"Expenses are often downplayed because the magnitude of a fund's return in a given year can dwarf their impact," said Value Line Mutual Fund Survey editor Stephen Savage. "Yet a high expense ratio will have an impact year in and year out."

Those costs won't go away.

"Be concerned about cost, for many people expect total returns on both stocks and bonds will be a lot lower in the 1990s than they were in the 1980s," warned Amy Arnott, analyst with the Morningstar Mutual Funds investment advisory. "A fund with high expenses may have to take on more risk by investing in areas such as derivative securities to try to get over its expenses."

Several funds recommended by Morningstar include:

* Benham GNMA Income, Mountainview, Calif.; $987 million in assets; no load or 12b-1 fees; expense ratio, 0.54 percent.

* Fidelity Equity Income II, Boston; $7.7 billion; no load or 12b-1 fees; expense ratio, 0.84 percent.

* Franklin High Yield Tax Free income, San Mateo, Calif.; $3.3 billion; 4.25 percent load; 12b-1 fees, 0.10 percent; expense ratio, 0.53 percent.

* Lindner, St. Louis; $1.58 billion; no load or 12b-1 fees; expense ratio, 0.56 percent.

* Nicholas, Milwaukee; $2.9 billion; no load or 12b-1 fees; expense ratio, 0.78 percent.

* Vanguard Fixed Income Short Term Corporate, Valley Forge, Pa.; $3.1 billion; no load or 12b-1 fees; expense ratio, 0.29 percent.

* Vanguard Index 500, Valley Forge, Pa.; $9.4 billion; no load or 12b-1 fees; expense ratio, 0.19 percent.

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