Study: U.S. Investors Waste $36 Billion on Wall St. Fees

By Will McClatchy, Co-Founder and
Jim Wiandt, Site Editor, IndexFunds.com

In 2000, mutual fund investors overpaid Wall Street $36 billion to manage stocks, bonds, and real estate totalling $3.7 trillion. Nearly 1% per year of assets were wasted in unnecessary fees, according to IndexFunds' comprehensive new survey of mutual fund fees.

# of funds considered	8,545
Total invested ($millions)	$3,738,342,970,000
Fees actually paid ($millions)	$46,967,540,861
Ave. actual annual expense ratio	1.26%
Ave. benchmark fund expense ratio	0.29%
Projected unnecessary expense	0.97%
Total $ wasted ($millions)	$36,188,973,586

In every category of mutual fund, well-established and broadly-diversified alternative funds offer significantly lower fees than the average fees investors actually pay. If investors switched to such alternative funds, they would significantly lower their cost of investing.

Numerous studies have shown that, on average, fund returns before fees in an investment category will tend to follow the average performance of of that category unless greater risk is taken on. Low fees are therefore the best way for the average investor to maximize their returns.

Overview

This study sought to examine whether individual U.S. mutual fund investors are paying competitive fees for money management services. It concluded that they are not, due to high management fees.

First, actual fees expected to be paid in 2000 were estimated for 8,545 mutual funds available to individual investors in the U.S. This was calculated by multiplying assets of the fund by annual fees as reported by management.

Second, fees investors would have paid had they invested in a broadly-diversified, low-cost benchmark fund in the same fund category were computed.

The difference is the amount of unnecessary management expense.

To ensure fair comparisons between the entire universe of mutual funds and low-cost benchmark funds, benchmark funds in each of 41 investment categories were carefully selected.

Active mutual fund investors pay 0.97% of their investment above and beyond the basic cost of investing in their asset class for the privilege of trying to beat the market. This is over three times the cost of basic investing (0.29% on average) in the relative safety of a low-cost fund broadly diversified within a major asset class.

List of Benchmark Funds for 41 Investment Categories

Study Methodology

The study began with data covering over 10,000 mutual funds
representing all mutual fund options open to investors in North America.

The following were eliminated from the sample:

• any fund that wasn't open to new investors
• institutional funds (defined as those requiring more than $25,000 initial deposit)
• funds which had been in open for less than a year
• funds without assets

Eliminating funds according to the above criteria left a total of 8,445 funds divided into 41 groups.

Benchmark Selection

A low-cost, broadly-diversified leader (benchmark) was selected from among funds in each of 41 investment categories. The benchmark fund was a broadly-diversified fund that ranked in the top of 50% for net asset value in its category. Benchmarks could not carry a front load and had to be available for purchase to any retail investor.

The difference in annual operating expenses between the low-cost leader and its
rival funds in each category was calculated. That amount was multiplied by the
total assets under management for each fund and totaled.

Average Returns Assumption

What individual investors should conclude about this study depends on how easy they believe it is to beat the average performance of funds in their category, before fees.

Dozens of empirical studies examining many decades of data in numerous
markets have failed to show any reliable strategy for beating a market or asset class. When high fees are subtracted from their returns, actively-managed mutual fund investors consistently underperform the market, on average.

Some investment analysts, typically professionals who earn their wages from
recommending how to beat the market, maintain that investors can reliably
beat the market. No major study has ever shown such strategies to work for the average mutual fund investor.

See a PDF of the full text (174 pages) of the study.

10/10/2000