Do the stock market's big swings have you feeling helpless?
Although you can't control what happens in Shanghai -- or the fact that troubles in China can drag down stocks here by 10 percent in just over a week -- you do have control over one crucial factor affecting your portfolio: how much you pay in expenses. So use this past week's stock shock as a reminder to take charge of what you can control, and keep fees low to hold onto more of your savings.
It may seem logical to expect the more expensive option to be the better one, but investing isn't like choosing between fresh and day-old sushi. Low-cost funds historically have performed better than higher-cost rivals, according to Morningstar. That's because low-cost funds have a built-in advantage: Their higher-cost rivals need to make more just to match their competitors' performance after expenses are taken into account.
Encouragingly, more investors are choosing lower-cost funds. The latest evidence comes from a report released this month about how workers are investing in their 401(k) accounts. They paid an average of $54 in fees for every $10,000 invested in stock mutual funds last year, according to the Investment Company Institute, a trade group for funds. That figure was $74 in 2009 and has been on a steady downward trend for the last decade.
Expenses also dropped in 401(k) plans for bond funds, where keeping expenses low can have an even bigger impact. That's because bonds are paying slim amounts of interest -- the 10-year Treasury note has a yield of about 2 percent -- and higher expenses can quickly eat away those returns.
You may not notice when a mutual fund charges its fees. There's no bill that needs to be paid. Instead, funds simply deduct expenses from their total assets. The total amount deducted, divided by the fund's total assets, is what the industry calls a fund's expense ratio. The number is shown as a percentage, and it's an easy way to compare fund expenses.
Some funds charge an additional one-time fee, called a load, to investors when they either enter or exit the fund. Most investors avoid these, and 87 percent of dollars invested in mutual funds in 401(k) accounts last year were in no-load share classes.
Workers who have access to 401(k) accounts generally enjoy lower fund expenses than everyone else, because the plans can grant them access to the "institutional" share classes of funds. These share classes are generally reserved for pension funds and other big investors who can pony up $1 million or more, and they correspondingly offer lower expenses.
Vanguard has an institutional fund that tracks the Standard & Poor's 500 index with an expense ratio of 0.04 percent, for example. To get in requires an investment of at least $5 million, but some regular investors can also invest through their 401(k) plans. Vanguard's S&P 500 fund for average investors who put in less than $10,000 has an expense ratio of 0.17 percent.
Investors are heeding the call for lower-cost funds outside 401(k) plans as well, according to a report issued by Morningstar earlier this year.
Over the last decade, 95 cents of every $1 that has gone into mutual funds and exchange-traded funds went into those with an expense ratio in the bottom 20 percent of all funds.
One big reason for the trend is the rising popularity of index mutual funds and ETFs. Instead of trying to pick winning stocks and avoid losing stocks, index funds track the performance of the S&P 500 or another index. And because they don't hire teams of analysts, index funds generally charge lower expenses. As a group, stock index funds keep $11 of every $10,000 invested to cover expenses, versus $86 for actively managed stock funds.
But costs are dropping for actively managed funds too, and their average expense ratio is down to 0.86 percent from 1.06 percent in 2000.
The large amount of money moving into low-cost funds is also helping to lower costs. That's because bigger funds can spread fees over a broader base of investors, which leads to a lower expense ratio. Some funds also have a policy of charging lower rates once their total assets get above a certain level.
So, while you don't have a say in what's driven the stock market to these big recent swings, you do have a way to hold onto more of what's yours. Sometimes you get what you don't pay for.