Do the stock market’s big swings have you feeling helpless?
Although you can’t control what happens in Shanghai — or the fact that troubles in China can drag down stocks here by 10 percent in just over a week — you do have control over one crucial factor affecting your portfolio: how much you pay in expenses. So use last week’s stock shock as a reminder to take charge of what you can control, and keep fees low to hold onto more of your savings.
It may seem logical to expect the more expensive option to be the better one, but investing isn’t like choosing between fresh and day-old sushi. Low-cost funds historically have performed better than higher-cost rivals, according to Morningstar. That’s because low-cost funds have a built-in advantage: Their higher-cost rivals need to make more just to match their competitors’ performance after expenses are taken into account.
Encouragingly, more investors are choosing lower-cost funds. The latest evidence comes from a report released this month about how workers are investing in their 401(k) accounts. They paid an average of $54 in fees for every $10,000 invested in stock mutual funds last year, according to the Investment Company Institute, a trade group for funds. That figure was $74 in 2009 and has been on a steady downward trend for the past decade.
Expenses also dropped in 401(k) plans for bond funds, where keeping expenses low can have an even bigger impact. That’s because bonds are paying slim amounts of interest — the 10-year Treasury note has a yield of about 2 percent — and higher expenses can quickly eat away those returns.
You may not notice when a mutual fund charges its fees. There’s no bill that needs to be paid. Instead, funds simply deduct expenses from their total assets. The total amount deducted, divided by the fund’s total assets, is what the industry calls a fund’s expense ratio. The number is shown as a percentage, and it’s an easy way to compare fund expenses.
Some funds charge an additional one-time fee, called a load, to investors when they either enter or exit the fund. Most investors avoid these, and 87 percent of dollars invested in mutual funds in 401(k) accounts last year were in no-load share classes.
Workers who have access to 401(k) accounts generally enjoy lower fund expenses than everyone else, because the plans can grant them access to the “institutional” share classes of funds. These share classes are generally reserved for pension funds and other big investors who can pony up $1 million or more, and they correspondingly offer lower expenses.
Vanguard has an institutional fund that tracks the Standard & Poor’s 500 index with an expense ratio of .04 percent, for example. To get in requires an investment of at least $5 million, but some regular investors can also invest through their 401(k) plans. Vanguard’s S&P 500 fund for average investors who put in less than $10,000 has an expense ratio of .17 percent.
One big reason for the low-cost trend is the rising popularity of index mutual funds and ETFs. Instead of trying to pick winning stocks and avoid losing stocks, index funds track the performance of the S&P 500 or another index.
