Load Mutual Funds: The Right Way to Look at Fees and Expenses
by Sam Subramanian of AlphaProfit.com
When searching for the best no load mutual funds, some
mutual fund investors often tend to focus exclusively on
mutual fund fees and expense ratios. Is this always a smart
way to select mutual funds?
Metrics such as price/earnings ratio and dividend yield
on the S&P 500 index, a commonly used proxy for the
U.S. stock market, are hardly at bargain levels. This has
lead several market pundits to predict single digit annual
returns for domestic mutual funds over the next decade.
While pursuing the search for the best mutual fund, some
mutual fund investors tend to focus exclusively on fees
and expense ratios. The rationale is that by choosing mutual
funds with low fees, investors will have more of their capital
invested. Also, no load mutual funds with low expense ratios
will pass on more of the returns they earn to their shareholders.
Is shopping for the lowest fees and expense ratios a smart
way to select mutual funds? Not always. The answer depends
on the type of mutual fund you are evaluating, the time
you can devote to evaluating and managing your mutual funds
investments, and the type of cost incurred.
Investing in the Best No Load Index Mutual Funds.
If you believe markets are generally efficient and prefer
to invest in an index mutual fund to achieve an index-like
return, shopping for the best index mutual fund based on
low fees and a low expense ratio makes good sense. The portfolio
manager of an index mutual fund endeavors to invest the
fund's assets to track the index as closely and cost-effectively
as possible. Larger index funds have an advantage in that
they can spread their operating costs over a larger asset
Some of the interesting index mutual fund options currently
available include no load index mutual funds like E*Trade
S&P 500 Index Fund (Nasdaq: ETSPX), Fidelity Spartan
500 Index Fund (NASDAQ: FSMKX), and Vanguard 500 Index Fund
(NASDAQ: VFINX) with expense ratios of 0.09%, 0.10%, and
Investing in Actively Managed Mutual Funds and Strategies.
Mutual fund fees and expenses are just one of several important
factors to consider if you believe portfolio managers can
add value and outperform the index through active management.
The portfolio manager's ability and investing style are
just as important. Therefore, seeking out the best mutual
fund based on just low fees and a low expense ratio may
not always be the right approach. It may just be a case
of being 'penny-wise and pound-foolish'.
Legendary investor Peter Lynch, who managed the Fidelity
Magellan Fund (NASDAQ: FMAGX) from 1977 to 1990, achieved
returns well in excess of the market averages even after
accounting for the fund's fees and expenses.
So too has Bill Miller who currently manages the Legg Mason
Value Trust (NASDAQ: LMVTX). Even after accounting for its
relatively high 1.7% expense ratio, this no load mutual
fund has achieved compound annual returns of 18.6% for the
10 year period ending in 2004, well in excess of 12.0% for
the Vanguard 500 Index mutual fund.
an investment research firm that specializes in active sector
investing, uses the no load Fidelity Select Funds to implement
its investing strategy through its Core and Focus
model portfolios. Although not the lowest, the expense ratio
of the no load Fidelity Select Funds compares favorably
with that of other sector fund offerings. AlphaProfit prefers
Fidelity Selects for their comprehensive coverage of sectors
and industry groups. The AlphaProfit model portfolios have
significantly outperformed the market averages over time.
Ensuring Your Mutual Fund Puts Your Interest First.
Whether you prefer to index or take an active approach
to managing your investments, ensuring that your mutual
fund is putting your interests first is good investing practice.
Mutual funds charge different types of fees. By looking
at some key factors pertaining to fees, you can get a sense
of whether the mutual fund puts your interests first or
merely seeks to line the mutual fund company's pockets.
Serving the Interests of Long-Term Shareholders.
Some mutual funds impose short-term trading fees to discourage
frequent trading of mutual fund shares. Frequent trading
disrupts efficient management of the mutual fund and increases
operating expenses. A short-term trading fee can therefore
actually be beneficial to long-term shareholders if the
fee is rightly treated by the mutual fund company.
Fidelity Spartan Total Market Index Fund (NASDAQ: FSTMX),
for example, follows the practice of returning short-term
trading fees collected on shares held less than 90 days
to the mutual fund itself rather than passing on the benefit
to the mutual fund company. By having this short-term trading
fee structure, this no load mutual fund seeks to contain
its operating expenses. Such fees are therefore aligned
with the interests of long-term shareholders of this mutual
Passing on Savings from Scale Economies. The operating
expenses incurred by a mutual fund are a combination of
fixed and variable costs. As the assets of a mutual fund
increase, the fixed cost gets spread over a larger asset
base. Therefore, the expenses incurred to operate the mutual
fund as a percentage of the fund's assets should trend lower.
A mutual fund that places the interest of shareholders
first must pass on the savings from scale economies to shareholders.
The trend in a mutual fund's expense ratio therefore serves
as a metric of how seriously a fund takes its fiduciary
- If you are searching for the best no load index mutual
fund, shopping for one with low fees and expenses makes
- If active management of investments appeals to you,
fees and expenses are just one of several important factors
to consider. The ability and investing style of the portfolio
manager are at least just as important as fees.
- The types of fees a mutual fund charges and how the
fund uses the fees provides clues as to how seriously
a mutual fund takes its fiduciary responsibility. Mutual
funds that impose fees to contain operating expenses and
return fees to the mutual fund help protect the interests
of long-term shareholders.
- Mutual funds that put the shareholders' interests first
typically pass on savings from scale economies to the
Sam Subramanian, PhD, MBA is Managing Principal of AlphaProfit
Investments, LLC. He edits the AlphaProfit Sector Investors'
Newsletter, a publication that discusses investments
using Fidelity mutual funds. For the 5 year period ending
December 31, 2004, during which the Dow Jones Wilshire 5000
Total Market Index declined 6.9%, the AlphaProfit model
portfolios increased by up to 186.2%, a compound average
annual return of 23.4%. To learn more about AlphaProfit
and to subscribe to the FREE newsletter, visit http://www.alphaprofit.com.
No part of this document may be reproduced
in any manner without written permission of AlphaProfit
Investments, LLC. Copyright © 2005 AlphaProfit Investments,
LLC. All rights reserved.