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High Fees Are a Drag on Mutual Fund Performance

Updated on February 26, 2017
John Bogle
John Bogle

High Mutual Fund Fees Limit Investors' Returns

A recent unanimous U.S. Supreme Court decision in Jones v. Harris provided a bit of relief for mutual fund investors victimized by high fees but did not go far enough. The court's decision said that when retail mutual fund directors bargain with advisers over their charges they should compare the fees with "relevant" fees paid by "different types of clients," i.e., institutional clients like pension funds, as well as with other retail funds purchased by small investors. The defendant in the case, Harris Associates, a Chicago mutual fund adviser and Fidelity Management and Research in an amicus brief, claimed that "apples-to-oranges comparisons between fees paid by mutual funds and those paid by institutional clients, such as pension funds" were inappropriate. The plaintiffs, investors in Oakmark funds pointed to the fact that pension funds typically pay only about half the fees charged mutual funds, even when the mutual funds are much larger than the pension funds and even when the portfolios recommended by the advisers are virtually identical.

For example, one study showed that public pension funds compared with mutual funds using similar investment strategies paid fees paid half the fees paid by mutual funds. The mutual funds had average assets of $1.3 billion compared with $443 billion in the pension funds. Despite the mutual fund's much larger size it paid advisory fees of 0.05 percent, twice that of the pension funds. In raw dollars, the mutual funds (i.e., the investors) paid six times as much on average, $7.28 million compared to $1.2 million paid by the pension fund. The study included only investment advisory fees not administrative costs brokerage fees or any other costs, according to Professor John P. Freeman of the University of South Carolina, co-author of the study.

However, the Supreme Court decision stopped short of ordering comparable fees for mutual funds. The decision provided only that mutual fund directors have breached their fiduciary duty only when an adviser's fee is "so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arms-length bargaining." Nevertheless, mutual fund directors are now on notice that they should be doing a better job of looking after the interests of mutual fund investors.

John Bogle, originator of the index fund and founder of the Vanguard mutual funds, which is owned by fund investors and operated in their interest, has been a thorn in the mutual fund industry's side for many years, never passing up an opportunity to criticize industry practices including excessive advisory fees which he believes are not in the interest of investors. He has long been an advocate of no-load, low cost, tax efficient mutual funds like the ones offered by Vanguard which are the lowest in the industry. Sales charges or loads, high advisory fees and other costs add up to significant performance penalties in retirement or any long-term investment account.

[I'm indebted to an article in the NY Times, May 7, 2010, entitled "That Nagging Question Of Mutual Fund Fees" by Jeff Sommer. http://www.nytimes.com/2010/05/09/business/09stra.html?scp=1&sq=Jefrf%20sommer&st=cse]


Warren Buffett on Hedge Funds' Dismal Performance

In his 2016 letter, Buffett took special aim at hedge funds, which in recent years have faced persistent outflows of investor money because of poor performance, stubbornly high fees, and a broad move toward cheaper, passive options like index funds and exchange-traded funds.

Underscoring his long-held thesis that, over time, highly paid hedge-fund hotshots lose out to a cheap index fund, Buffett presented the latest results of a bet he made nine years ago. Since then, a standard S&P index fund overseen by Vanguard is up 85 percent, easily outpacing the hedge funds’ return of 22 percent. Annually, the gap is just as wide: 7 percent for the index fund and 2.2 percent for the hedge funds.

As usual, Buffett did not mince words in expressing his astonishment as to how elite investment professionals could register such mediocre returns while raking in steep fees.

“I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal — really dismal,” he wrote. “And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved — fees that were totally unwarranted by performance — were such that their managers were showered with compensation over the nine years that have passed.”

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    • Jeff May profile image

      Jeffrey Penn May 7 years ago from St. Louis

      Interesting... I haven't had any money to invest in anything recently, but years ago, I worked with a finacial advisor... and still have a portfolio, but never knew much about the fees, and when I asked, was told that "you'll have to pay one way or another." Makes me think I probably paid more that I should have.

    • Ralph Deeds profile image
      Author

      Ralph Deeds 7 years ago from Birmingham, Michigan

      Very possibly, especially if your "advisor" was getting a commission on the investments he recommended for you. You are better off working with a fee only registered financial advisor. Brokers and advisors who get a commission from anything they get you to invest tend to put their own interest ahead of their clients because that's how they get paid--by recommending the investment products that pay them the biggest commission which likely aren't the best for their clients.

      Thanks for your comment, Jeff.

    • msorensson profile image

      msorensson 7 years ago

      Thank you, Ralph.

      Educational. I was never into mutual funds precisely because of what you said.

    • profile image

      Philip Chandler 7 years ago

      Thank you for such an informative article. Sadly, with the Roberts Court in power, I see little relief ahead for the small investor...

      PHILIP

    • philipcfromnyc profile image

      Philip Chandler 7 years ago from Queens, NY

      Thank you for such an informative article. Sadly, with the Roberts Court in power, I see little relief ahead for the small investor...

      PHILIP

    • ethel smith profile image

      Eileen Kersey 7 years ago from Kingston-Upon-Hull

      Fees and commission are so often hidden.

    • Petra Vlah profile image

      Petra Vlah 7 years ago from Los Angeles

      Thank you so much Ralph for sharing your knowledge about things that the regular investor needs to be aware of.

    • H P Roychoudhury profile image

      H P Roychoudhury 7 years ago from Guwahati, India

      It is good to think twice before making investment.

    • Research Analyst profile image

      Research Analyst 7 years ago

      penny stocks seem to be the best investment instead of mutual funds lately

    • Ralph Deeds profile image
      Author

      Ralph Deeds 7 years ago from Birmingham, Michigan

      Penny stocks can be fund to fool around with with a small amount of money. I don't consider them an "investment."

    • cajunrooster profile image

      John David LeCoq 7 years ago from San Antonio, Texas

      This is a great hub again Mr. Ralph. My wife and I try to find funds that are run well and that have low fees, but there are not that many around. We also try to invest in socially responsible funds. We can't always do that with retirement money since the fund choices are limited. I do like to play with penny stocks, but they are just a hobby. You really can't consider them an investment. I have done quite well with some, but I always take my money and invest it in something much more solid if I make some dollars. Thanks for another great hub.

    • Ralph Deeds profile image
      Author

      Ralph Deeds 7 years ago from Birmingham, Michigan

      Thanks for the comment. I'm a fan of Vanguard Group which is owned by its mutual fund investors and has the lowest fees in the industry.

      https://personal.vanguard.com/us/HomepageOverview?...

    • Ralph Deeds profile image
      Author

      Ralph Deeds 6 years ago from Birmingham, Michigan

      5-13-11NYTimes--Does Your 401k Offer Index Funds? It Should!

      Index Funds Should Be Offered in 401(k) Plans - NYTimes.com

      Index mutual funds are not required to be offered in 401(k) plans, but they should be, because of their many advantages over actively managed funds.

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