Mutual Fund Fees Will Continue to Decline
Mutual fund fees are slowly but surely heading to zero. At least that’s the conclusion of an industry analyst’s report:
“Fees have fallen, fees will continue to fall, and asset managers may, someday soon, pay you to invest in their products. This is a rational outcome of the price wars that passive investment managers have chosen to engage in.”
(Hat tip to the NY Times for reporting the story.)
It started years ago with Vanguard’s low-cost index funds and in 2018, Fidelity leapfrogged Vanguard by launching four zero-fee funds. It’s unlikely to end there.
What is the fee being referenced?
The “expense ratio” is the fee on which to focus with mutual funds. Every fund must disclose this fee and it represents the amount the fund company charges you to manage the fund. It is expressed as a percentage of your invested assets. A high cost fund would have an expense ratio that exceeded 1.0% and a low-cost index fund would be 0.1% or less.
You can find your fund’s expense ratio by simply googling that term along with the fund’s name or ticker symbol that should be noted on your account statement. To confuse you more, some funds have multiple share classes with differing fees and you need to be sure you’re checking the correct share class for your investments.
How can fund managers afford to charge no fee?
Not all of them can. Besides having little choice but to respond to the competitive pressures, there are two other reasons why the mutual fund companies may be willing to price at zero:
- They can cross-sell other more profitable products and services such as higher-priced mutual funds, high-margin financial advisory services, trading commissions, and 401K plan administration. For example, Fidelity’s Net Benefit retirement savings business has 23,000 employer-customers. At least half the clients I’ve worked with have a Net Benefits plan administered by Fidelity. That’s a big business for Fidelity.
- Mutual funds engage in a side business known as securities lending. The funds lend out their stock certificates to other investors who are typically using them to sell short those stocks. The fund earns fees for this service and with a large, low-cost, and well-run fund, these fees can be enough to make it profitable.
Those fund companies that don’t have enough scale to be large enough to operate with these low margins or do not have other more profitable services to cross-sell are at the greatest risk of this price war. Fidelity and Vanguard will do just fine; for their smaller competitors, it is not as clear.
What are the implications?
Consumers should expect low mutual fund fees. If you are incurring significant investment fees either directly in an IRA, or indirectly through an advisor or your 401K, you should reconsider your options. Paying a seemingly small additional 1% fee compounds into a substantial amount of lost savings over your lifetime, while offering you no benefit.