Best No Load Mutual Funds: The
Right Way to Look at Fees and Expenses
by Sam Subramanian
When searching for the best no load mutual funds, some
mutual fund investors often tend to focus exclusively on mutual fund fees and
expense ratios. Is this always a smart way to select mutual funds?
Metrics such as price/earnings ratio and dividend yield on
the S&P 500 index, a commonly used proxy for the U.S. stock market, are
hardly at bargain levels. This has lead several market pundits to predict single
digit annual returns for domestic mutual funds over the next decade.
While pursuing the search for the best mutual fund, some
mutual fund investors tend to focus exclusively on fees and expense ratios. The
rationale is that by choosing mutual funds with low fees, investors will have
more of their capital invested. Also, no load mutual funds with low expense
ratios will pass on more of the returns they earn to their shareholders.
Is shopping for the lowest fees and expense ratios a smart
way to select mutual funds? Not always. The answer depends on the type of mutual
fund you are evaluating, the time you can devote to evaluating and managing your
mutual funds investments, and the type of cost incurred.
Investing in the Best No Load Index Mutual Funds
If you believe markets are generally efficient and prefer
to invest in an index mutual fund to achieve an index-like return, shopping for
the best index mutual fund based on low fees and a low expense ratio makes good
sense. The portfolio manager of an index mutual fund endeavors to invest the
fund’s assets to track the index as closely and cost-effectively as possible.
Larger index funds have an advantage in that they can spread their operating
costs over a larger asset base.
Some of the interesting index mutual fund options
currently available include no load index mutual funds like E*Trade S&P 500
Index Fund (Nasdaq: ETSPX), Fidelity Spartan 500 Index Fund (Nasdaq: FSMKX), and
Vanguard 500 Index Fund (Nasdaq: VFINX) with expense ratios of 0.09%, 0.10%, and
0.18%, respectively.
Investing in Actively Managed Mutual Funds and
Strategies
Mutual fund fees and expenses are just one of several
important factors to consider if you believe portfolio managers can add value
and out-perform the index through active management. The portfolio manager’s
ability and investing style are just as important. Therefore, seeking out the
best mutual fund based on just low fees and a low expense ratio may not always
be the right approach. It may just be a case of being ‘penny-wise and
pound-foolish’.
Legendary investor Peter Lynch, who managed the Fidelity
Magellan Fund (Nasdaq: FMAGX) from 1977 to 1990, achieved returns well in excess
of the market averages even after accounting for the fund’s fees and expenses.
So too has Bill Miller who currently manages the Legg
Mason Value Trust (Nasdaq: LMVTX). Even after accounting for its relatively high
1.7% expense ratio, this no load mutual fund has achieved compound annual
returns of 18.6% for the 10 year period ending in 2004, well in excess of 12.0%
for the Vanguard 500 Index mutual fund.
AlphaProfit, an investment research firm that specializes
in active sector investing, uses the no load Fidelity Select Funds to implement
its investing strategy through its Core™ and Focus™ model portfolios.
Although not the lowest, the expense ratio of the no load Fidelity Select Funds
compares favorably with that of other sector fund offerings. AlphaProfit prefers
Fidelity Selects for their comprehensive coverage of sectors and industry
groups. The AlphaProfit model portfolios have significantly outperformed the
market averages over time.
Ensuring Your Mutual Fund Puts Your Interest
First
Whether you prefer to index or take an active approach to
managing your investments, ensuring that your mutual fund is putting your
interests first is good investing practice.
Mutual funds charge different types of fees. By looking at
some key factors pertaining to fees, you can get a sense of whether the mutual
fund puts your interests first or merely seeks to line the mutual fund company’s
pockets.
Serving the Interests of Long-Term Shareholders. Some
mutual funds impose short-term trading fees to discourage frequent trading of
mutual fund shares. Frequent trading disrupts efficient management of the mutual
fund and increases operating expenses. A short-term trading fee can therefore
actually be beneficial to long-term shareholders if the fee is rightly treated
by the mutual fund company.
Fidelity Spartan Total Market Index Fund (Nasdaq: FSTMX),
for example, follows the practice of returning short-term trading fees collected
on shares held less than 90 days to the mutual fund itself rather than passing
on the benefit to the mutual fund company. By having this short-term trading fee
structure, this no load mutual fund seeks to contain its operating expenses.
Such fees are therefore aligned with the interests of long-term shareholders of
this mutual fund.
Passing on Savings from Scale Economies. The operating
expenses incurred by a mutual fund are a combination of fixed and variable
costs. As the assets of a mutual fund increase, the fixed cost gets spread over
a larger asset base. Therefore, the expenses incurred to operate the mutual fund
as a percentage of the fund’s assets should trend lower.
A mutual fund that places the interest of shareholders
first must pass on the savings from scale economies to shareholders. The trend
in a mutual fund’s expense ratio therefore serves as a metric of how seriously
a fund takes its fiduciary
responsibility.
Key Points.
- If you are searching for the best no load index mutual
fund, shopping for one with low fees and expenses makes perfect sense.
- If active management of investments appeals to you,
fees and expenses are just one of several important factors to consider. The
ability and investing style of the portfolio manager are at least just as
important as fees.
- The types of fees a mutual fund charges and how the
fund uses the fees provides clues as to how seriously a mutual fund takes
its fiduciary responsibility. Mutual funds that impose fees to contain
operating expenses and return fees to the mutual fund help protect the
interests of long-term shareholders.
- Mutual funds that put the shareholders’ interests
first typically pass on savings from scale economies to the shareholders.
Notes: This report is for information purposes
only. Nothing herein should be construed as an offer to buy or sell securities
or to give individual investment advice. This report does not have regard to the
specific investment objectives, financial situation, and particular needs of any
specific person who may receive this report. The information contained in this
report is obtained from various sources believed to be accurate and is provided
without warranties of any kind. AlphaProfit Investments, LLC does not represent
that this information, including any third party information, is accurate or
complete and it should not be relied upon as such. AlphaProfit Investments, LLC
is not responsible for any errors or omissions herein. Opinions expressed herein
reflect the opinion of AlphaProfit Investments, LLC and are subject to change
without notice. AlphaProfit Investments, LLC disclaims any liability for any
direct or incidental loss incurred by applying any of the information in this
report. The third-party trademarks or service marks appearing within this report
are the property of their respective owners. All other trademarks appearing
herein are the property of AlphaProfit Investments, LLC. Owners and employees of
AlphaProfit Investments, LLC for their own accounts invest in the Fidelity
Mutual Funds included in the AlphaProfit Core and Focus model portfolios.
AlphaProfit Investments, LLC neither is associated with nor receives any
compensation from Fidelity Investments or other mutual fund companies mentioned
in this report. Past performance is neither an indication of nor a guarantee for
future results. No part of this document may be reproduced in any manner without
written permission of AlphaProfit Investments, LLC. Copyright © 2005
AlphaProfit Investments, LLC. All rights reserved.
Sam Subramanian, PhD, MBA is Managing Principal of
AlphaProfit Investments, LLC. He edits the AlphaProfit Sector Investors'
Newsletter™, a publication that discusses investments using Fidelity mutual
funds. For the 5 year period ending December 31, 2004, during which the Dow
Jones Wilshire 5000 Total Market Index declined 6.9%, the AlphaProfit model
portfolios increased by up to 186.2%, a compound average annual return of 23.4%.
To learn more about AlphaProfit and to subscribe to the FREE newsletter, visit http://www.alphaprofit.com.
