Watch out for fees
NEW YORK – The appeal of an index fund is that you’ll get the same return as the broad market. But because of the high fees at some funds, the reality is you may not.
If you’re shopping for an index fund, or if you’re already invested in an index fund and you’re looking to change, check out the fee calculator at the National Association of Securities Dealers, http://apps.nasd.com/investor_Information/ea/nasd/mfetf.aspx.
To see the difference in returns, we picked three large index funds: Fidelity’s Spartan 500 Index Fund, the investor class shares of Vanguard’s 500 Index Fund and the Dreyfus S&P 500 Index Fund. We computed what the funds’ values would be if we invested $10,000 in each, with an assumed 6 percent rate of return and a 10-year holding period.
Under these conditions, the fund value at Spartan after 10 years would be $17,730.39, the fund value at Vanguard’s 500 index would be $17,589.32 and the value at Dreyfus 500 would be $17,037.25.
The fees would be $134.92 at Spartan, $241.69 at Vanguard and $658.74 at Dreyfus.
Of course, there’s no sure way to predict the future – a fund can change its fee policy in an instant, the market can stay flat for years, etc. But still, such a wide difference in fees may come as a surprise to investors who believe all index funds are the same.
That’s where a little bit of research can go a long way. Mutual fund research company Morningstar Inc., on its free Web site, gives succinct reviews of funds. Its one line on the Dreyfus fund: “There are cheaper and, hence, better index mutual funds than this one.” Its line on Vanguard is, “Are hidden costs cutting into this fund’s returns?” Its line on Fidelity’s Spartan is, “This mutual fund will likely remain tough to beat over the long term.”
If your only investment in mutual funds is through a 401(k) plan at work, it’s worth comparing the index funds in your plan to other fund companies’ index funds. If you find your plan’s index fund is overcharging by a significant margin, contact the members of the investment committee at your company and show them your comparison.
If you’re considering buying a fund, it’s worth looking at Morningstar’s stewardship grade, which it added in 2004. Morningstar assigns the grade, in part, by looking at a fund’s expense ratio and comparing it to the expense ratio of funds invested in a similar class of assets. It also evaluates whether costs have gone down as assets have grown, which they should, thanks to economies of scale.
Index funds are essentially fungible, said Mercer Bullard, president and founder of Fund Democracy, a mutual fund shareholders’ advocacy group. Fund Democracy and the Consumer Federation of America did a study of excess fees in 2003.
“The higher fees provide no additional benefits to shareholders and serve only to reduce investors’ returns and fatten fund managers’ profits,” Bullard said then.