Friday, August 16, 2013

Ignorance About High Expense – Ratio Mutual Funds

For many people, mutual funds present a great opportunity to gain from the volatility of the stock market. This is primarily the reason that the mutual funds industry has grown to have around $13 trillion in assets. It is not as if all mutual funds have turned out to be a tool for sound financial planning; several mutual funds have offered dismal returns to investors. While one may say that ups and downs are a usual feature of any volatile market, the fact is that some of the worst performing mutual funds have the high expense ratio in their class. An analysis done by financial experts at USA TODAY and Morningstar took a look at the mutual funds that paid the lowest returns to its investors despite charging high expense fees.

The report published in USA TODAY found a total of 23 stock mutual funds which were in the bottom 25% of the list of funds of similar class. On the other hand, these bottom 25% mutual funds were in the top league when it came to charging the highest amount to its investors for running the business.

In the last twenty years or so, mutual funds have gained a widespread acceptance among American investors. Most of these investors, who have white-collar or blue-collar jobs, do not have the time to understand the intricacies of stock markets (they will watch The Simpsons instead). Mutual funds provide a perfect opportunity to these investors to get better returns than what their conservative banks have to offer them. However, in the process of getting somebody else to do the investing for them, these investors fail to do the required research and analysis. Although the conversation centered on a mutual fund is conveniently embellished with jargon, it is prerogative of an investor to know the terms and conditions of an offer before he signs on the dotted line. Because of the ignorance of the investors, crucial parameters such as Return on Investment (ROI) and expense-ratio get overlooked.

Financial experts have been urging mutual fund investors to look at expense-ratio more closely, particularly after the economic crisis of 2007-08. The expense ratio is an estimate of the percentage of the assets that the managers of the mutual fund use to run the business. It includes costs associated with managing the fund, paying salaries to the analysts, customer service, 12b-1 distribution fee. Out of all the costs that an investor pays to the mutual fund, the one that gets frequently panned is the 12b-1 distribution fee. Simply put, it is the fee that goes into marketing and advertising the fund so that new investors sign up for the mutual fund. A lot of investors are unknowingly paying for selling their mutual fund company to potential investors. Therefore, it is always recommended to see the terms and conditions of the offer in detail and know about every penny that you put into the mutual fund. Awareness about this can go a long way in ensuring that you deal with only those mutual fund companies that give prominence to the interests of the investors. According to the US TODAY article we are quoting, Legg Mason Cap. Value Trust C fund had a 5-year return of -35%, while its expense ratio stood at a staggering 1.71%. Another fund, Federated Kaufmann R had a 5-year return of -9% despite having an expense ratio of 1.95%.


It is in the interest of investors to look closely at those mutual funds that fall into the category of low-return and high expense. The information is there for all to see, and considering the economic climate that we are living in, it is important that investors are aware about their interests.

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