By: Richard Feldman, CFP, AIF, MBA
The first mission of a mutual fund company is to make money for themselves. The second mission for a mutual fund company is to make money for their shareholders. The only problem is the first principle can have a dramatic impact on the second. Mutual fund expense ratios have been steadily rising since 1994. With the amount of money that has flowed into the mutual fund industry you would think economies of scale would be reached and expenses at fund families would have fallen. But according to Morningstar the average expense ratio of a US diversified equity fund has risen from 1.33% in 1994 to 1.51% in 2003. This means that the fund company is taking 1.5% of total assets every year to cover expenses of the fund’s management. The environment has recently brightened dramatically for investors seeking a lower cost alternative to high expense ratio funds because of the price war between Vanguard and Fidelity.
Investor Solutions has written extensively on the benefits of low cost funds and how investors can keep more of their returns and give less to the mutual fund industry by using index funds. (See Investor Solutions Learning Center). The costs of owning a mutual fund are called the expense ratio. The expense ratio represents the percentage of the fund’s assets that go purely toward the expense of running the fund. The expense ratio covers the investment advisory fee, the administrative costs, 12b-1 distribution fees, and other operating expenses.
Fidelity Spartan Funds
Fidelity initially came out and implemented a 10 basis point charge or .10% on their Spartan Equity mutual funds, marketing these funds as the so called “Perfect 10s”. Vanguard fired back announcing that Fidelity had the wiggle room in their prospectus to revert back to their previous higher expense ratios at anytime should Fidelity choose to. Fidelity answered this criticism by capping the expense ratios of the following five Fidelity Spartan Index Funds at 0.10%. The funds are Fidelity Spartan 500 Index, Fidelity Spartan Total Market Index, Fidelity Spartan Extended Market Index, and Fidelity Spartan International Index, and Fidelity Spartan U.S. Equity Index.
Vanguard Admiral Shares
In response to Fidelity’s perfect 10s (Although Vanguard says it is not), Vanguard has broadened the availability of their low cost Admiral Shares. Admiral Shares are lower cost funds that were typically available for individual investors who had $250,000 invested in a particular Vanguard fund. Under the new rules, investors with fund accounts of $100,000 or more will automatically qualify for the lower cost Admiral shares. Investors with $50,000 will qualify if they have a ten year history in a fund. Vanguard says that about $225 billion in new and existing assets qualify for Admiral status. Currently there is approximately $125 billion in Admiral shares meaning that another $100 million has instantly become Admiral shares eligible. According to Dan Wiener, the editor of the Independent Advisor for Vanguard Investors, this will cost Vanguard approximately $90 million in fund fees per year.
Fees Make a Difference
The difference over a 30 year period on a $10,000 investment, assuming annual gross returns of 10%, would mean an account value of $144,500 for an account in the Fidelity Spartan Funds, compared with $96,200 for the investor using funds with an expense ratio of 1.51%.
Industry analysts have speculated that the price cuts on Fidelity and Vanguard’s Index Funds are a loss leader for their actively managed funds. The reduction in fees on the Index Funds will eventually draw more assets to the fund group and their actively managed funds that carry a higher expense ratio. Regardless of the reason the ultimate beneficiary is the investor. Lower cost alternatives allow investors to put together diversified portfolios at a drastically reduced cost. Whatever the reason is for the expense reduction individual investors will benefit from it.
 Top Funds at fire-sale prices, Tim Middleton, MSN Money; September 7th, 2004
Price Wars Help Individual Investors Increase Wealth
By: Richard Feldman, CFP, AIF, MBA