From Financial Integrity

Mutual Fund Expense Ratios – do they matter?

At the close of 2009, Morningstar.com did its annual analysis of mutual fund expense ratios, stating that 2009 saw the largest spike in costs since 2000. The article provided analysis for why that is (market dives lead to sell-offs and rebalancing, and therefore increased trading fees), but most importantly, it answers the question, “why does this matter?” Answer: Expense ratios tend to predict performance. Remember the Step 9 "low-cost" criteria for investments? It’s wise in more ways than one -- Morningstar found funds in the cheapest quintile are 7 times more likely to survive and outperform than those in the highest-cost quintile.

An interesting example was highlighted in an April 2010 Wall Street Journal article pointing out that high fund performance does not necessarily equate with high investor return. CGM Focus large cap fund was the decade’s “best-performing” mutual fund, with an 18% annualized rate of return, yet investors in the fund experienced a yearly loss of 11% within that period. This was pinned to the high turnover rate of holdings within the fund, and a high turnover of investors themselves, as people dove in when the fund was high-performing, and ran when it wasn’t.

The average mutual fund churns 85% of its holdings annually, resulting in trading costs, and generating taxable gains for non-deferred accounts. CGM Focus – the “best performer” had a turnover rate of 504%! Of course volatility is one of the prime problems plaguing the market these days – and keeping the entire economy on tenterhooks for the next dive (computer-generated or otherwise.)

The questions these reports raise for FI’ers: Where is your life energy invested, how much is it costing you, and is it contributing to long-term prosperity?

SEC Mutual Fund Expense Calculator

Need help figuring it out? Get Rich Slowly has a great post about how to read a mutual fund prospectus.

(Note: Morningstar.com and the Wall Street Journal require free registration to read these articles.)