In their search for the best no load mutual funds, some investors tend to select mutual funds based solely on their fees and expense ratios. The rationale is that by choosing mutual funds with low fees, investors can have more of their capital invested. Also, no load mutual funds with low expense ratios will pass on more of the returns they earn to their shareholders. However, metrics such as price/earnings ratio and dividend yield on the S&P 500 index, a commonly used proxy for the U.S. stock market, are hardly at bargain levels. Several market experts forecast single-digit annual returns for domestic mutual funds over the next decade.
Is shopping for the lowest fees and expense ratios the right way to select mutual funds? Not always. The answer depends on the type of mutual fund you are evaluating, the time you can devote to evaluating and managing your mutual fund’s investments, and the type of cost incurred.
Investing in the Best No Load Index Mutual Funds:
If you believe markets are generally efficient and prefer to invest in an index mutual fund to achieve an index-like return, shopping for the best index mutual fund based on low fees and a low expense ratio makes perfect sense. An index mutual fund’s portfolio manager seeks to invest the fund’s assets to track an index as closely and as cost-effectively as possible. Larger index funds have an advantage since they can spread their operating costs over a larger asset base. Some of the interesting index mutual fund options currently available include no load index mutual funds like E*Trade S&P 500 Index Fund (Nasdaq: ETSPX), Fidelity Spartan 500 Index Fund (Nasdaq: FSMKX), and Vanguard 500 Index Fund (Nasdaq: VFINX) with expense ratios of 0.09%, 0.10%, and 0.18%, respectively.
Investing in Actively Managed Mutual Funds and Strategies:
If you believe portfolio managers can add value and out-perform the index through active management, fees and expenses are just one of several important factors to consider. The portfolio manager’s ability and investing style are just as important. Therefore, seeking out the best mutual fund based on just low fees and a low expense ratio may not always be the right approach. Ensuring Your Mutual Fund Puts Your Interest First.
Whether you prefer to index or take an active approach to managing your investments, ensuring that your mutual fund is putting your interests first is a good investing practice. Mutual funds charge different types of fees. By looking at some key factors concerning fees, you can get a sense of whether the mutual fund puts your interests first or merely seeks to line the mutual fund company’s pockets.
Serving the Interests of Long-Term Shareholders – Some mutual funds impose short-term trading fees to discourage frequent trading of mutual fund shares. Frequent trading disrupts efficient management of the mutual fund and increases operating expenses. A short-term trading fee can therefore actually be beneficial to long-term shareholders if the fee is rightly treated by the mutual fund company.
Passing on Savings from Scale Economies – The operating expenses incurred by a mutual fund are a combination of fixed and variable costs. As the assets of a mutual fund increase, the fixed cost gets spread over a larger asset base. Therefore, the expenses incurred to operate the mutual fund as a percentage of the fund’s assets should trend lower.
A mutual fund that places the interest of shareholders first must pass on the savings from scale economies to shareholders. The trend in a mutual fund’s expense ratio, therefore, serves as a metric of how seriously a fund takes its fiduciary responsibility.