You invest to enhance your wealth and, as an investor, you don't want a mutual fund's high fees and poor performance cutting into your savings.
All mutual funds charge internal, ongoing management fees. These fees are used to pay fund managers, analysts, brokerage and marketing expenses, administrative costs, and, in the case of load funds, commissions to the salespeople. The good news is that fees, on average, are lower than 15 years ago, but only marginally. The bad news is that they are still higher than they should be, in many cases.
Testing Your Funds
To help you make smarter decisions, perform the following simple test to make certain you're getting a good value for your invested dollars:
Step 1. Retrieve your most recent investment statement listing all of the mutual funds you currently own.
Step 3. In the first column, write down the asset class of each fund using one of four broad categories: domestic stock, international stock, taxable bond, and municipal bond. If you are not certain, go to the Fund section of Morningstar.com and type in the name of your fund. You should have no trouble identifying its asset class category.
Step 5. Under the Total Returns section of Morningstar.com for your fund, find the Trailing Total Returns section for your fund and write in column 3 the ranking for 3 and 5 years. The lower the number here, the better. For example, a 25 under the 3-year Trailing Return indicates that your fund has performed in the top 25 percentile of all funds in its category.
Evaluating the Results
Once you have finished assembling these data for each fund you own, you are ready to do a quick evaluation. First, compare each of your funds' expense ratio to the industry average listed here: Domestic stock: 0.93
Taxable bond: 0.85
Are your funds' expense ratios higher than the industry average?
Next, look at the Trailing Total Returns for each of your funds. Are the Trailing Total Returns higher than 50? If so, this indicates that your fund's performance over a long time period is in the bottom half of its category. Furthermore, if its expense ratio is above average, you may very well be paying too much while receiving poor performance to boot. If you're in this situation, you should consider switching to a fund that has below-average expenses and above-average 3- and 5-year returns.
A good place to start your search is at fund companies such as Vanguard, Dodge & Cox, and Fidelity, which all offer low-cost, no-load funds. For load funds, the runaway leader is American Funds.
Stewart H.Welch III, CFPÂ®, AEP, is the founder of the Welch Group, LLC, which specializes in providing fee-only wealth management services to affluent retirees and health care professionals throughout the United States. He is the coauthor of J.K. Lasserâ€™s New Rules for Estate and Tax Planning (Wiley; 2005). He welcomes questions or comments at 800-709-7100 or visit www.welchgroup.com. This article was reprinted with permission from the Birmingham Post-Herald.