What’s the secret? Look for the funds with the lowest costs. That’s all there is to it. Over time, low-cost funds will outperform any other funds you might choose in that same investment category.
The evidence comes from a study done by Morningstar, which rates mutual funds, based on their past performance adjusted for risk.
“In every single time period and data point tested, low-cost funds beat high-cost funds,” Morningstar’s research director Russel Kinnel wrote.
By the way, this is also my personal mantra. All the mutual funds that I hold in my own retirement account carry rock-bottom costs.
A fund’s published cost is called its “expense ratio.” If you invest $30,000 and pay $300 in annual fees, your expense ratio is 1 percent. That $300 is deducted from your investment returns. You’ll find the expense ratio in the prospectus, your 401(k)’s fee-disclosure sheet, the fund’s online site or perhaps in the sales material you get.
How do you tell if the fee you’re paying is high or low? Here are the 2011 averages for mutual fund expense ratios, from the Investment Company Institute:
Growth funds – 1.37 percent; growth and income – 1.21 percent; international – 1.57 percent. Taxable bond – 1.03 percent. Municipal bond – 0.99 percent.
The “average” is too much to pay for a mutual fund. The cost reduction of just 1 percent will give you tens of thousands of dollars more when you retire.
You’ll pay the least for index funds (my favorites) that follow the market as a whole. You’ll also find lower-cost funds at the Vanguard Group, Fidelity Investments and T. Rowe Price that levy no sales charges; or discount brokers such as Charles Schwab. Traditional brokerage houses sell the most expensive mutual funds.
Low-cost funds are the closest thing in investing to a free lunch! They’re on the menu of almost all 401(k) plans today. Every dollar you don’t pay to a mutual fund company is a dollar more you’ll have spend when you’re 65.