Fund fees differ, so compare with care

PERSONAL FINANCE

July 16, 2000|By EILEEN AMBROSE

When investors buy a mutual fund these days, they're likely to base their decision on the fund's sector or performance. That's not unimportant, of course, but the General Accounting Office wants more investors to think about fees.

The cost of running a mutual fund, which all shareholders share, is disclosed as a percentage and deducted from the fund's assets before returns are calculated. Funds also must disclose in the prospectus the dollar amount investors would pay in operating fees based on a hypothetical portfolio.

But to hit home to investors just how much they're shelling out, the GAO recently recommended that funds be required to disclose in quarterly statements the dollar amount each shareholder's account is charged to cover operating costs.

Such dollars-and-cents disclosures might encourage fund companies to be more competitive on fees, too, possibly even lowering them, the government agency reported.

Mutual fund companies' fee revenues have skyrocketed in the past decade, thanks in part to a healthy jump in fund assets. According to a GAO survey, the 77 largest stock and bond funds collected $7.4 billion in fees in 1998, almost 560 percent more than in 1990.

The average expense ratio, that is, the operating fees in relation to a fund's assets, fell 12 percent among stock funds and 6 percent among the bond funds, the GAO survey found. Some funds in the survey, however, didn't cut fees and even raised them, the GAO noted.

Consumer advocates and fund experts say the more disclosure about fees, the better. Some, though, are not sure the added information will change the way investors buy funds. Investors have their eyes on performance, often overlooking the fact that fees eat into performance, experts said.

"The mutual fund world really tries to get people to focus on returns, particularly when the markets are good," said Christopher P. Parr, a fee-only financial adviser with Parr Financial Solutions in Columbia.

He predicts that investors will take more notice of fees if the market weakens over a couple of years. If a fund is charging, say, 3 percent in fees but the returns are 6 percent or 8 percent, "all of sudden, that's a big deal," he said.

The GAO's recommendation is in the hands of the Securities and Exchange Commission, which will decide whether to adopt the change. The Investment Company Institute, the mutual fund trade association in Washington, said it will review the GAO report with the SEC and Congress.

In the meantime, experts recom- mend that investors weigh fees when considering mutual funds.

"Expenses are one of the few things that you can control that affects performance," said Barbara Roper, director of investor protection for the Consumer Federation of America. "You can choose low-cost funds."

Indeed, the lowest-cost funds have the best returns on average among their peers, said Scott Cooley, a senior analyst with Morningstar, a mutual fund tracking firm in Chicago. "They're basically starting the race ahead of their peers" because fees are subtracted before returns are figured, he said.

Fees are spelled out in the prospectus and, basically, fall under two categories: shareholder fees and annual operating expenses.

Shareholder fees include compensation to financial advisers who help investors pick the funds best suited for them. The commission can be paid up front, on an annual basis, or a combination of annually and at the back-end when the shares are sold. Back-end fees generally disappear after a few years.

Not everyone pays shareholder fees, but all investors pay annual operating costs. These cover the cost of money management; marketing and distribution, also called a 12b-1 fee; and services such as record keeping, mailing and phone assistance.

Parr recommends that investors compare fees among similar kinds of funds. For instance, you can't compare a large cap domestic fund with an international fund because the latter will have higher transaction and research costs.

Cooley suggested that investors use the Vanguard Group, a Pennsylvania fund company known for its low-cost funds, as a benchmark when comparing fees.

Be aware that some funds sell multiple classes of shares and each class has its own way of compensating financial advisers, said Tim Chase, a fee-only financial planner with Wealth Management Services in Towson. Class A shares, for instance, typically have an upfront fee, or load, and Class B shares may have a back-end load and annual sales fee, he said.

The class that's best for you depends on how long you plan to own the fund, Chase said. For instance, long-term investors are almost always better off with Class A shares and paying the sales charge upfront, he said.

Although there are good funds that carry front-end or back-end loads, Roper advises against load funds. "Our basic recommendation is, go with a no-load fund and eliminate that cost," she said.

Parr said he tries to avoid funds with 12b-1 fees, which can cover advertising or sales commissions, but don't add value to the fund.

To figure out the impact of fees on your investment, check a mutual fund cost calculator on the Web, Roper said. Such calculators are available on the sites of the SEC (www.sec.gov) and Personal Fund Inc. (www.personalfund.com), co-founded by financial author Andrew Tobias.

Remember, fees may appear small at first glance, but are not small change over many years. The GAO figured the impact of an expense ratio jumping from 1 percent to 2 percent on a $10,000 investment earning 8 percent a year. Over 20 years, the investor's total return would be cut by $7,000.

Do you have a personal finance issue of general interest that you would like to see addressed in this column? Contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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