Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, January 24, 1994 TAG: 9401220060
SECTION: MONEY PAGE: A-10 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Medium
Some of these considerations are: the type of fund, its investment objectives, its track record and its economic outlook.
But investors often overlook one important factor, according to the Institute of Certified Financial Planners.
That is a fund's expense ratio, which can make a significant difference in performance. This is especially true in the case of bond funds.
The expense ratio of a mutual fund is different from what is commonly called the fund's load.
A load is a sales charge paid each time you put money into (or, in some cases, take money out of) a mutual fund.
While many mutual funds don't have front- or back-end loads, all of them have expense ratios.
The expense ratio, the institute said, is the percentage of a fund's net assets that goes annually to cover management fees, transaction costs, administrative and office overhead, legal and auditing fees and marketing costs. The last are known as 12b-1 fees.
You can find a fund's expense ratio in its prospectus, under the heading "annual fund operating expenses."
Unlike the one-time load, annual expenses are an ongoing, and somewhat invisible, cost that - if high enough - can drag down a fund's overall performance, the financial planners said.
One study of performance showed that a $10,000 investment in two no-load mutual funds, each earning 9 percent over 20 years, would grow to $30,475 in a fund with a 3 percent expense ratio and to $45,840 in the fund with a 1 percent ratio.
The 3 percent figure is unusually high, but the institute said such costs do exist.
Where expense ratios often have the greatest impact on performance is in bond funds, the institute said.
In part, this is because bond funds historically have been less volatile than stock funds.
And returns vary less among similar types of funds, such as tax-free municipal bonds or short-term corporate bond funds, than they do in a stock fund category where management can be more active.
A recent study by CDA-Wiesenberger found a direct correlation among 100 funds that invested in longer-maturity government bonds.
The 25 funds with the highest five-year average annual expenses (1.57 percent) had the lowest five-year average annual return (8.66 percent).
On the other hand, the 25 funds with the lowest average expenses (0.53 percent) had the best returns (9.91 percent).
Because many costs remain fixed regardless of the size of any mutual fund, expense ratios tend to be lower for larger funds than for smaller funds.
The institute said expenses also tend to vary widely depending on the type of fund.
For example, international funds usually have higher transaction and administrative costs than, say, a domestic index fund.
Specialized funds, such as precious metals or small company stocks, tend to have higher expenses.
So it is important when you pick funds that you compare expense ratios in similar-type funds.
The financial planners said you should look for funds with above-average performance and below-average expenses.
However, the institute warned, you should not necessarily pick a fund based solely on its expense ratio.
One fund may have a higher expense ratio than another, but yet have a consistently superior performance because of the abilities of an active management - although it may have earned those superior gains by assuming added risk.
With more modest market returns expected in the years just ahead, the planners said, expense ratios will be a more important factor than ever.
by CNB