By Katy Marquardt

When it comes to mutual fund investing, cost matters -- a lot. Studies show that over time, funds with highest relative returns are often the cheapest. What's more, funds with steep annual expenses tend to have weaker management, higher risk strategies, and fewer resources, according to Russel Kinnel , Morningstar's director of fund research.

Funds roll management fees, administrative costs, and marketing expenses into one package, which is expressed as the expense ratio -- and that's the fee you pay annually as a shareholder. When comparing expense ratios, it helps to know what the typical fees are in a given asset class. The median annual fee for a no-load, large-cap fund is 0.95 percent, while the median for small-cap funds is 1.20 percent and for international stock funds, 1.23 percent, according to Morningstar. Index funds and exchange-traded funds generally charge much less (The annual fees for Vanguard's Total Stock Market Index fund, for example, are just 0.18 percent.)

The differences in fees often sound like chump change, but consider this: If you put $10,000 into a fund with a 0.4 percent expense ratio that earns an annualized 7 percent over 20 years, you'll have $36,000 -- $7,300 more than if you had invested in a fund with a 1.5 percent expense ratio (which earned the same return over that period).

So how much is too much to pay? "If [expenses are] higher than 2 percent, you should probably be finding a new provider," says Rob Lutts, president at Cabot Money Management in Salem, Mass. Opinions, of course, vary: The American Association of Individual Investors' advice is to think twice before investing in a bond fund with an expense ratio approaching 1 percent, or a stock fund that charges more than 1.5 percent.

As the above averages show, some fund categories are generally more expensive than others: The annual fees for international funds tend to be higher than those of U.S. funds, and small-cap funds are generally more pricey than large-cap funds. An often-cited reason for the latter is that smaller companies require more research and therefore tend to be more expensive to manage. The same goes for niche funds that invest in a particular sector.

But when it comes to crowded categories such as large-cap funds, "[companies are] competing for the core investment for most investors," says Andrew Gogerty, a senior fund analyst with Morningstar. "You have a lot of managers searching in the same pool of stocks, so with large-cap stocks, it's really hard to get an edge ... it's not hard to see that the manager with the lowest hurdle tends to win."

Gogerty says it's rare to see a large-cap fund charging more than 130 basis points (or 1.30 percent). "Go outside that, and you have to be really confident in the manager's ability to deliver a significant amount of outperformance over the index," he says. "Beating the index by [one percentage point] a year is a tall order in the large-cap space ... there better be something extremely special about it."

Two factors that influence fees are competition and size, says Gogerty. When a category contains a relatively small number of funds, pricing competition isn't as fierce, he says, so funds are able to charge a bit more. Funds with low total assets -- especially new funds -- often have higher expenses because their fixed cost of operation is divided among a smaller asset base.

It's a good idea to not only compare the expenses of funds in the same category, but also consider their performance versus peers. "A lot of funds charge 1.5 percent per year to manage, and they don't do any better or they do the same as the S&P 500 -- which can be purchased through an [exchange-traded fund] at 0.08 percent," says Lutts. "That's a lot of return you'll give up." Funds disclose their annual expenses in their prospectus or annual report. Investors can find out what the average fees are for a fund's given category on Morningstar.com, as well as compare its performance to that of its peers.

Of course, some funds overcome their high costs and outperform peers or their benchmark index. Take Berwyn Cornerstone, a no-load, large-value fund with approximately $8.8 million in assets that charges 2 percent annually. Over the past five years, the fund's annualized return beat both the S&P and its peers by about 3 percentage points. But 2 percent is a high hurdle to jump in order to deliver a better return than a fund charging much less.

It's probably not worth fretting over miniscule differences in fees, especially if you're investing small amounts, says Gogerty. "When you're talking 1 or 2 basis points on actively managed funds, it's not as big of a deal. But be cognizant and look at the big picture. Ask yourself, 'What am I paying for?'" The bottom line: In most cases, the lower the expenses, the better.

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