Congress and the Securities and Exchange Commission have started poking around under the hood of this $6.5 trillion industry. There are problems: investors receive little information about what they pay in fees and are often overcharged when they buy funds, according to the General Accounting Office. While you’re waiting for the Feds to act, here’s how to avoid some traps:
Beware of broker-promoted funds. Some fund companies pay brokerage firms extra to push their funds. Ask your broker if there’s a revenue-sharing deal with the fund company he’s suggesting. For the convenience of a one-stop shop, try opening an account on E*Trade (etrade.com), which announced last week it will rebate half the money it collects in similar sales charges. Or invest directly in funds, like those offered by Vanguard Investments (Vanguard.com), that don’t pay the extra fees to list with other brokers.
Search for hidden fees. Many funds have sweetheart deals with companies that do their trading. Fund companies overpay the trading companies’ costs in what insiders call “soft dollars.” The trading companies then kick back some of that to the fund companies in the form of stuff like extra research and computer equipment. The bottom line: higher costs for investors. The industry’s trading-cost average is about 5.2 cents a share, versus the 0.85 cents that it should cost, according to American Century (www.americancentury.com), a mutual-fund firm that doesn’t pay soft dollars. Others are Bridgeway (bridgewayfunds.com) and TIAA-CREF (tiaa-cref.org). Get a handle on how much your fund is paying on trades by checking the Statement of Additional Information that fund companies must file with the SEC. (Ask the company.) Or restrict your investments to funds that expense below the average 1.6 percent for stock funds and 1 percent for bond funds.
Invest in cheap alternatives. Most funds fail to make those extra fees and expenses worthwhile. Only 1.5 percent of actively managed large-cap funds outperformed the S&P 500 in every one of the past –four years, according to Strong Investments. For just 0.18 percent a year, buy the Vanguard 500 Index Fund. Or check out exchange-traded funds. You’ll pay a one-time commission in and out, but if you’re a long-term investor, it’s hard to beat the 0.11 percent annual costs of the Spider 500, which mimics the S&P 500 Index. For every $50,000 you invest, the Spider charges $55 a year in management fees. The Vanguard fund charges $90, while the typical large-cap fund asks for a whopping $640.
You can skip funds altogether and try a relatively new investment called a folio that’s sold online at foliofn.com. These are baskets of individual stocks, assembled like fund portfolios, but with an important difference: you own the stocks themselves, rather than holding them indirectly through a fund. That gives you opportunities for tax breaks you don’t get in a mutual fund. It also lets you hold expenses down. You can buy three portfolios for $295 a year. Trade to your heart’s content with all the fun of investing and no hidden fees.
