S&P funds don’t fit all

When your car is running on empty, you pick your filling station based on convenience and, these days, price. That’s because gasoline is a commodity: You’ll wind up with essentially the same stuff no matter where you buy it.

Based on this logic, you might assume one Standard & Poor’s 500 mutual fund is as good as another, but a recent study by the Investment Company Institute suggests these widely held securities are far from one-size-fits-all. Even though their underlying holdings are practically identical, variations in asset levels, account size, minimum investment requirements and, most of all, fees, can have a significant impact your total return. Ignore these factors, and you might wind up paying too much at the financial services pump.

S&P 500 funds are mutual funds that mirror the returns of the S&P 500 index, an unmanaged basket of 500 large-cap domestic stocks, considered by many on Wall Street as the best benchmark of the U.S. equity market. As of June 2005, there were 65 S&P 500 index funds available, holding a combined $255 billion in assets, which represents about half of all the dollars shareholders have placed in stock index funds, according to the ICI, the industry’s biggest trade group.

Since little or no effort is spent on research, portfolio management fees at S&P 500 funds are fairly uniform and low, ICI found. But expense ratios, which reflect ongoing expenses incurred by shareholders, range widely, from a low of about 0.10 percent to a maximum of 1.8 percent.

The main question to ask if you own or are shopping for an index fund is how much advice you need, and how you want to pay for it. Much of the cost disparity in S&P 500 funds is due to the fact that some funds charge 12b-1 fees and others don’t, said Sean Collins, chief economist with the ICI. These ongoing charges pay for advertising and marketing costs, and can be used to compensate brokers.

“If you go with a direct-marketed, no-load fund, you’d be a do-it-yourselfer. You don’t get any financial advice, you don’t need it, but you also don’t incur the 12b-1 fee,” Collins noted. “It’s just a question of whether you need financial advice and are willing to pay for it or not.”

Not surprisingly, since index fund buyers tend to be bargain shoppers, the S&P 500 funds with the lowest costs tend to attract the most business. Those with expense ratios of 0.40 percent or less capture more than 90 percent of money flows, Collins said.

Just as you might not want to drive all over town looking for the cheapest gas, there are valid reasons why you might not buy the absolute cheapest S&P 500 index fund. Some investors are willing to pay a bit more because they see advantages in keeping all their money with one shop; perhaps they get better overall rates if they maintain a larger portfolio, or they like getting a consolidated statement. If you prefer doing business in person, and there’s a convenient brick-and-mortar location close by, that could influence your decision. But if you’re paying more than half a percent, you probably should start asking questions.

If you consider yourself a do-it-yourselfer, as many index investors do, paying ongoing expenses on a fund you intend to hold for many years doesn’t make a whole lot of sense, said Richard A. Ferri, a fee-only money manager based in Troy, Mich., who has written several books on investing.

“To me, fees are everything. How much are you willing to pay for advice? Should that fee be baked into the price of your S&P 500 fund, or should it be on the side?” Ferri asked. “My opinion is it should be on the side. You go to someone for advice, here’s the index fund, and here’s the fee for the advice.”