It costs money to run a mutual fund and investors should gravitate toward funds that cost less than average to operate. Mutual funds as a class of investments are excellent low-cost instruments for most investors. But their low-cost average obscures those funds whose operating costs are significantly higher than average.
Operational costs detract from a fund’s net return. A fund that earns 10% in one year and had operating expenses equal to 1% of assets will distribute a 9% gain to shareholders. Another fund that also earns 10% but has operating expenses of 2.5% will only distribute 7.5% to shareholders. Mutual fund expenses include everything from the cost of advertising and the cost of trading investments held by the fund to the cost of stuffing envelopes with quarterly statements for shareholders.
Costs are one of the few predictable performance variables when shopping for a fund. Investors should compare the costs of funds they are considering to appropriate benchmarks. A survey of costs from 1998 through 2002 using Morningstar Inc. data showed the large U.S. growth stock funds cost 1.18% of assets to operate while large value stock funds cost 1.04%. Here are other benchmarks to use when evaluating mutual fund costs: Small U.S. value, 1.22%; small U.S. growth, 1.39%; mid-cap U.S. value, 1.22%; mid-cap U.S. growth, 1.27%; large international value, 1.15%; large international growth, 1.47%; high quality domestic intermediate term bond, 0.84%.
