Mutual Fund Madness Versus ETF Sanity

The Investment Company Institute (the ICI) reported that investors paid an average of 1.13% in expenses on stock mutual funds in 2005. Sean Collins, An ICI spokesperson, says that there is "a conscious choice of fund investors to move toward lower-cost fund complexes", becausee 90% of all stock fund assets are in funds with below-average expense ratios. The Wall Street Journal, echoing this theme, titled its article Investors Flock to Mutual Funds with Lower Fees.

What???

1.13% is a stunningly high percentage of assets to be paying every year for fund management. This number probably includes low-cost index funds from Vanguard and Fidelity, suggesting that most retail investors are parking their savings in actively-managed mutual funds with average expenses higher than 1.13%. And we know that the average actively managed mutual fund trails the market by about 3% per year.

I must admit, I find the self-congratulation of the mutual fund industry, in this case by the ICI, a trade group, to be stomach-churning. It claims that on average investors are paying 0.04 percentage points less in fees on stock funds than last year, and that 70% of new cash is flowing into funds with expenses of less than 1%.

Big deal. The annual expenses (excluding the one-off trading costs) of the sample ETF portfolio I put together for The Radical Guide to Investing is 0.26%. And a simple all-stock portfolio consisting of 5 ETFs -- the iShares S&P 500 ETF (IVV), iShares Mid Cap 400 Index ETF (IJH), the iShares Russell 2000 Index ETF (IWM), the iShares MSCI EAFE Index ETF (EFA) and the Vanguard Emerging Markets VIPERs (VWO) -- would cost even less than that.

When will retail investors wake up?

Comments

[User 1:]

I smiled as I read your comment, Jon. Yes, been there, done that. My solution was to end up actually building the portfolios for family members in their online brokerage accounts. Hold their hands while they move brokers ("Did you know you can earn more interest with E*Trade?" helped), then set up a portfolio of ETFs and closed end funds (for India, Turkey etc) for them, and then ask them to rebalance once a year. Only problem was they wanted me to do the rebalancing as well!

2006 Jun 12 01:42 PM