Financial advisors should take note: American investors, on average, are paying less for mutual funds than ever before, yet many still end up in high-cost funds that can drastically reduce their returns, the New York Times writes.
Costs Are Lower Overall, But Disparity Remains the Same
The highest-cost actively managed funds had $326 billion in outflows last year, according to an analysis of open-end mutual funds and exchange-traded funds performed by Morningstar and cited by the publication. Meanwhile, the lowest-cost index funds had $429 billion in inflows, according to Morningstar. Low-cost passive funds accounted for 32% of the market in 2016, compared to just 23% in 2012, the Times writes.
What’s more, the popularity of low-cost funds helps them become ever cheaper, since more assets lead to lower expenses that could be passed on to the investor, the Times writes. But while this effect would suggest that costs would drop across the fund industry, that’s simply not the case, according to the publication.
Morningstar found that the average asset-weighted expense ratio of index funds has fallen to 0.17%, the Times writes. Yet the average fee on active funds is still 0.75%, according to Morningstar.
In fact, Michael J. Cooper, a professor of finance at the University of Utah, Michael Halling of the Stockholm School of Economics and Wenhao Yang of the University of South Carolina have found that the difference between the highest- and lowest-cost funds has remained unchanged across 20,000 equity mutual funds available in the U.S. from 1966 in 2014, the Times writes.
What this means for advice clients’ portfolios can be stark. On a 48-year horizon, someone investing in a high-cost fund instead of a close-to-identical low-cost fund would earn 70% to 145% less, according to the report.
Such disparity isn’t unique to esoteric funds, the Times writes. Cooper found that an investor in the lowest-cost S&P 500 index fund made 22% more from 2000 to 2014 than someone who bought the highest-cost funds, according to the Times. And the investor’s choice when it comes to finding the lowest-costs funds can be vast: just for the S&P 500, there are 50 different funds and 150 different share classes, according to Morningstar data cited by the publication.
The difference in fees are explained in part by scalability: Vanguard’s 500 Index Fund’s Admiral shares cost 0.04% in part because of the fund giant’s economies of scale, Joseph Brennan, director of global equity indexing at Vanguard, tells the publication. The fact that Vanguard is owned by its mutual fund shareholders also provides further incentive to sell funds at a minimum cost, according to the Times.
Meanwhile, A shares of the Rydex S.&.P. 500 Fund, meanwhile, come with a 1.55% fee and also charge a 4.75% sales fee, the publication writes. That’s because the fun has fewer assets under management, Ivy McLemore, a spokesman for Guggenheim Investments, which offers the Rydex funds, tells the Times. In addition, the fund is priced twice a day, since it’s aimed at tactical traders, according to McLemore.
Investors and their advisors, however, have several tools to pick out the lowest-cost funds appropriate for them: both The Financial Industry Regulatory Authority and Feez.com lets investors analyze fund fees, the Times writes.
Commentary on the New York Times article by M.P. Dunleavey
Posted by: The Wealth Advisor
