worth finding out.”
Portnoy says that a few years ago, when funds were returning 20% a year, paying 2% in fund expenses might not have seemed worrisome: “However, if we’re entering into a time when investment returns will be around 6% a year, as some people have suggested, paying 2% to a fund means giving up one-third of your gains.” You’ll be much better off with a fund that charges you 1%, or even less.
How much can you expect to pay when you invest in funds? According to Morningstar, diversified stock funds have average expense ratios around 1.5%. A mutual fund’s expense ratio expresses the percentage of assets deducted yearly for costs such as marketing, management, and administration. It doesn’t include transaction fees or commissions paid. For example, a fund with $100 million in assets that spends $1.25 million on the aforementioned costs would have an expense ratio of 1.25%. International and specialty stock funds have slightly higher expenses, while most bond funds charge investors approximately 1% per year. To help guide you, this year’s 80 top-performing mutual funds are ranked by their average annual three-year return as well as their expense ratio. (See table in this story.)
Many funds have been able to keep expenses low. Ariel (ARGFX), for example, is a value fund specializing in small companies.
The average small-cap value fund has an expense ratio of 1.53%. Ariel’s expense ratio is 1.19%, or 0.34 percentage points (34 basis points) below the norm. And low costs have given the Ariel fund an excellent track record. “We’re very focused on trying to hold down expenses,” says John W. Rogers Jr., CEO of Ariel Capital Inc. and portfolio manager of the Ariel fund and the Ariel Appreciation fund. “Our directors hold us accountable for the money we spend. At the end of the day, low expenses make a difference. We’ve been running Ariel fund for 17 years. An extra 25 or 50 basis points a year, for 17 years, can increase an investor’s return substantially.”
How does Ariel keep its overhead low? “We’re buy-and-hold investors,” says Rogers, “so we don’t do a lot of trading. When you reduce your trading costs, that helps to lower a fund’s overall costs.” Rogers advises investors to look closely at a fund’s turnoverâ€“how often shares are bought and soldâ€“before investing. Morningstar puts the average turnover rate for a domestic stock fund at about 100% (the average fund’s annual trades are about equal to the assets it holds), so funds with much lower turnover rates may have relatively low costs.
Rein in retirement fund expenses. If you invest in mutual funds through your company’s retirement plan, low expenses should be among the reasons you pick your funds. Darryl E. Kelson, 39, a FedEx dispatcher in Charlotte, North Carolina, does all of his mutual fund investing inside the company’s 401(k) plan. “I’ve been aggressive because I expect to have many years before I retire,” he says. “And I know that stocks have been best over the long term.”
Therefore, Kelson has