A break for investors: lower fees on index offerings
Today's sideways stock market is hard on mutual-fund companies. Most can't boast great returns. They can't argue prices are so low that it's a great time to buy. So in the race to lure new investors, funds have to find other ways to promote themselves.
Their latest tactic: fee chopping.
In what could be one of the greatest boons to individual investors in recent years, many mutual funds are cutting the fees they charge. The most visible price reductions have come in index funds - investment vehicles that are already inexpensive because they try to match the performance of markets rather than beat it.
"It's always a good time to consider index funds, and it's just getting better now that cheaper options are available," says Dan McNeela, a senior fund analyst at Morningstar Inc. in Chicago. "This highlights the very low costs some investors are charged for index funds. Over time, such low costs help support good returns."
Although the price-cutting has been going on for some time, the movement gained big momentum in August, when Fidelity Investments cut the expenses on five of its index funds from as much as 0.47 percent to 0.10 percent. As a result, investors in those funds will pay just $1 in fees annually for every $1,000 they invest.
Analysts saw Fidelity's move as an attempt to compete with Vanguard, the leader in low-cost index funds. A week later, E*Trade, the discount brokerage that also sells mutual funds, cut expenses on two of its index funds to 0.09 percent. In all, during the past year (ending July 31), 528 mutual funds decreased fees at the portfolio level, according to Lipper Inc., while 124 funds raised fees.
Lowering fees might bring more investors to index funds, which hold stocks in companies that make up a market index, such as the Standard & Poor's 500. But experts caution against making wholesale switches without considering the potential costs.
Fidelity, for example, is waiving part of its fees to reach the 0.10 percent level, which means the company is eating any additional costs. This also means the fee waiver could be lifted at some point, Mr. McNeela warns. By comparison, expenses of the Vanguard 500 Index fund, 0.18 percent, reflects the actual cost of managing the fund.
Another consideration: taxes. In a taxable account, any savings from buying a lower-cost option could be wiped out by the taxes owed on any profits from selling the first fund. "[Investors] should consider what their potential capital-gain situation would be if they sold one fund and bought another with lower costs," McNeela points out.
Those deciding the lower fees are worth making a move into index funds should also weigh what role they should play in a portfolio.
That role should be sizable, argues Fred Bair, manager of the T. Rowe Price Equity Index 500 Fund. Despite his admitted bias toward index funds, Mr. Bair believes they can act as a "risk-reduction tool" against actively managed funds where managers try to outperform the market.
Two of the most popular types of index funds follow the S&P 500 and the much broader Wilshire 5000 Index. Others track international stock market indexes such as the Morgan Stanley EAFE (Europe, Australia, Far East) Index and bond funds that follow such indexes as the Lehman Brothers Aggregate Bond Index. Those who don't mind a little more risk can buy as little as one share of Nasdaq's QQQ. This index is traded on the Nasdaq stock exchange and mirrors the collective performance of the Nasdaq 100, which includes a range of industries including computer hardware and software, telecommunications, and biotechnology.
"You can put together a very nice portfolio of just index funds if you like," McNeela adds. "Or, you can use an index fund as a core holding and build a portfolio of actively managed funds around it."
Some advisers think they can do better for clients without index funds. "We haven't used index funds for three or four years," says John Blankinship, a certified financial planner in Del Mar, Calif. Since the beginning of the bear market in the spring of 2000, Mr. Blankinship has recommended a few actively managed funds that he thinks have done a better job for investors, such as Longleaf Partners, the Oakmark Fund, and the Dodge & Cox Stock Fund. "We believe our recommended managers will outperform the index. These guys are good value managers."