The markets will always go up and down and investors can never know for sure what type of return they’ll get on their investments. However, one thing they can control is how much they pay for managing their money.
Management fees and expenses eat directly into returns, so investors will want to do everything they can to keep expenses at a minimum. In this article, we’ll examine the current trends in mutual fund fees and how investors can use those trends to their advantage.
Over the past 20 years, mutual fund expense ratios have declined significantly across the board. According to ICI Research, the average expense ratio on equity funds has dropped from 1.04% in 1996 to 0.63% last year. Bond fund expenses have dropped from 0.84% to 0.51%, while money market expense ratios have gone from 0.52% to 0.18%. Part of the downtrend in fees is thanks to the emergence of ultra-low-fee index funds and the general growth of the mutual fund industry, which has swelled from $3.5 trillion in assets in 1996 to $16.3 trillion in 2016.
Why the Trend Is Down
Index funds, which don’t require teams of managers and analysts running them, have been a driving force in the decline of fund fees, but they’ve been far from the only reason. When considering all of the factors involved, it’s reasonable to believe that expense ratios could continue declining from here.
Greater awareness of fees – The internet has been a great resource for getting easily digestible information in front of investors. The objective, composition and fee structure of funds is accessible to everyone with just a few clicks as fund providers try to promote greater transparency. Also helping is the transition away from thick prospectuses full of legal jargon and towards fact sheets that hit all the important points in just a single page.
Fighting for investor dollars – Whenever there’s rapid growth in an industry, an influx of competitors looking to get in on the action is sure to follow. That’s no different in the mutual fund arena, which now boasts more than 8,000 different funds. The best way to cut through the noise and get attention for your product is to make it cheaper than the rest.
The size advantage – Bigger providers such as Vanguard and Fidelity are using the mammoth size of their asset bases to undercut the competition on cost. These companies can charge less and still make their money because they’re working with a much bigger pie. It’s no coincidence that Vanguard had greater net mutual fund inflows in 2016 than all other mutual fund complexes with net inflows combined.
Regulatory pressures – The Department of Labor’s fiduciary rule has put pressure on investment managers to always act in the best interests of their customers. That’s going to push fund companies to eliminate any egregious or excessive fees. The SEC has recently increased its crackdown on companies that purposely put their customers into higher-fee accounts and exorbitant 12b-1 marketing fees.
The proliferation of ETF alternatives – If mutual funds have become cheap, exchange-traded funds are cheaper. ETFs are on the brink of breaking 2016’s record inflows of $287 billion, and it’s only August. Many investors prefer ETFs for their ultra-low fees and greater trading flexibility. Some of the interest in ETFs comes at the expense of mutual funds. ETFs still control just a small percentage of the overall financial markets and should present considerable competition to mutual funds for the foreseeable future.
Lower expense ratios are great for investors, but folks shouldn’t just go blindly targeting the cheapest funds. It is true that investors should always be seeking overall diversification at a reasonable cost. However, it is equally important to consider personal objectives and risk tolerances first. Before choosing specific funds, investors should develop an age and a risk-appropriate mix of stocks, bonds and cash for their portfolios. Only then should specific funds be targeted.
The Bottom Line
The overall downward trend in fund expenses is a good thing for investors. The marketplace has shown that investment dollars tend to be drawn to the cheapest products, which should push fund companies to continue lowering fees. Fee chasing isn’t a replacement for appropriate diversification and portfolio management, so investors should always consider objectives and risk tolerances before targeting low-fee products.
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