How important are expenses when consideringwhether or not to buy a mutual fund? Expensesmatter, as they have a direct impact ontotal return. But, while fees are a factor, they should beweighed in the larger context of a fund's performancerecord and the abilities of its manager. Mutual fundsincur routine costs that encompass operational expenses.Fortunately for investors, these costs are bundledtogether as a single number, the expense ratio.
A better way to understand the relative impact offees is to look at how a fund justifies its expenses. Is itconsistent in delivering above-average performanceand at what level of risk? How does the fund performin down markets? If a fund has outperformed its indexby 5% over the past 5 years, an expense ratio of, say,1.75% doesn't have much impact. That's especiallytrue if the fund's asset base is small, because expenseswill likely decrease over time. Physician-investorsshould always remember, however, that past performancedoes not guarantee future results.
In considering performance history, many investorsand advisors screen for 3-or 5-year track records, butit is essential not to discount newer and smaller fundswith seasoned managers who have solid records. Smallfunds, because they don't invest by committee, aremore likely to leverage the insights of a talented manager,providing an edge over other funds in the samecategory. Also, smaller funds define their own philosophy,control their investment process, and are often inpursuit of opportunities off the beaten path. Fees tokeep in mind when investing include the following:
•The 12(b)-1 fee. With the management fee, thisis the other principal component of the expense ratio.Originally intended to aid marketing efforts to growassets and benefit shareholders through economies ofscale, this fee is increasingly being used to pay distributorservicing expenses—essentially a sales charge.
•Performance-based fees. A common featurein the hedge fund world, this fee is gaining some tractionwith mutual funds. This fee structure rewards amanager only for generating returns in excess of anindex or other benchmark.
While fees are important, they should not be theonly factor used in selecting a fund. Sometimes a higherexpense ratio is actually a modest price to pay togain access to a bright manager with the latitude tofreely explore the market's complexities in search ofvalue and market-beating performance.
Funds to Keep an Eye On
One of the key strategies of successful retirementplanning is getting a good return from your investmentswhile also getting a good value. According to arecent article from Morningstar.com, the best valuefund managers charge reasonable fees. Three of thefunds they highlight are:
•T. Rowe Price (PRFDX), which charges anexpense ratio of 0.71%.
•Dodge & Cox (DODGX), which charges anexpense ratio of 0.52%.
•American Funds Washington Mutual (AWSHX),which charges an expense ratio of 0.57%.
Steven M. Rogé serves as portfolio manager at R. W. Rogé &Company, Inc and co-portfolio manager for the Rogé PartnersFund (Ticker: ROGEX). His responsibilities include the researchand analysis of mutual funds, limited partnerships, and individualcompanies. For more information, visit www.rwroge.com andwww.rogepartnersfund.com.