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Best No Load Mutual Funds: The Right Way to Look at Fees and Expenses
By Sam Subramanian
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Best No Load Mutual Funds: The Right Way to Look at Fees and Expenses
While 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.
Ensure 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 asset of a mutual
fund
increases, 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 the 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.
1. If you are searching for the best no load index mutual fund, shopping for one
with low fees and expenses makes perfect sense.
2. 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.
3. 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.
4. 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%, an average annual return of 23.4%. To learn more about AlphaProfit
and to subscribe to the FREE newsletter, visit http://www.alphaprofit.com.
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