Investors paying more, getting less

By Tim Middleton

The boys at American International Group (AIG, news, msgs) aren't the only ones raking in millions for losing other people's money.

Shareholders in the giant Fidelity Magellan Fund (FMAGX) recently saw their fees leap to $124.1 million for a single year via a 35.9% boost in the basic expense charge. Meanwhile, the fund, as of April 22, is down 43.8% in the past 12 months.

It's almost a percentage-for-percentage swap: The more of your money it lost, the more it charged.

And this Fidelity fund is hardly alone. More than 25% of mutual funds raised their expense ratios in 2008, according to Morningstar. Most of them acted for one or both of two related reasons:

• Fewer assets means higher unit costs per dollar invested.

• Management contracts often call for fee cuts when assets rise -- and vice versa. Market losses in 2008 were some of the largest in history, so assets fell.

Fidelity Magellan's story is a little different from most. Its managers got big raises in 2008 based on their performance the three previous years. This year they'll likely take cuts.

But the impact is the same: Magellan shareholders are paying more. While losing more.

A whole lot of investors are in this boat, and if your investments are sitting quietly in a 401(k) or an individual retirement account, you might not even notice.

Cold comfort: It's common

It's common for mutual fund fees to rise in bad markets, and this time around it could have been worse. Bond and money market funds did so well in 2008 that many of them actually cut fees. Further, so many fund complexes kept a lid on expenses, including giants such as Vanguard Group and American Funds, that the industry's asset-weighted fees actually declined, according to the Investment Company Institute.

But you need to check the expense records of the funds you own, especially if their performances have been really crummy, because you might be paying more for less.

"Investors should always pay attention to the fees their investments are charging. It has a great impact on long-term returns," says Jonathan Kreider, a research analyst at Lipper.

And if you find you're being gouged, dump that mutt and buy an exchange-traded fund. ETFs cost pennies compared with mutual funds. SPDR S&P 500 (SPY, news, msgs) went down 37% in the same period as Fidelity Magellan's 43.8% loss, in part because it charged investors only one-eighth as much in fees.

Flight from funds

Investors are already voting on this issue with their feet. According to Barclays Global Investors, ETFs enjoyed net sales in 2008 of $268 billion, while net sales of mutual funds were a negative $112 billion.

And ETFs aren't the only rivals to high-cost mutual funds. Plenty of mutual funds keep costs well under control. Not surprisingly, thrifty funds often outperform expensive ones, both because they are not dragged down as much by fees and because high-fee funds have to take greater risks to deliver the same net returns.

Here are some comparisons:

	Expense ratio in %	12-month performance in %
Large-cap growth funds
Fidelity Magellan (FMAGX)	0.72	-42.3
American Funds Growth Fund of America (AGTHX)	0.62	-36.1
Fidelity Blue Chip Growth (FBGRX)	0.57	-31.9
Vanguard Primecap (VPMCX)	0.43	-31.9
Large-cap value funds
Putnam Fund for Growth & Income A (PGRWX)	1.00	-36.6
American Funds Investment Company of America (AIVSX)	0.57	-33.2
Dodge & Cox Stock (DODGX)	0.52	-41.9
Vanguard Windsor II (VWNFX)	0.32	-37.0
Small-cap growth funds
Baron Growth (BGRFX)	1.32	-33.6
Fidelity Small Cap Growth (FCPGX)	1.10	-35.3
T. Rowe Price New Horizons (PRNHX)	0.84	-29.1
Vanguard Explorer (VEXPX)	0.44	-33.7
Small-cap value funds
Allianz NFJ Small Cap Value (PCVAX)	1.22	-31.6
Artisan Small Cap Value (ARTVX)	1.20	-24.4
Target Small Cap Value (TASVX)	0.73	-30.3
Vanguard Small Cap Value Index (VISVX)	0.23	-33.5
Foreign stock funds
Fidelity Overseas (FOSFX)	1.10	-48.4
MFS Institutional International Equity (MIEIX)	0.75	-41.1
American Funds EuroPacific (AEPGX)	0.74	-39.7
Vanguard International Growth (VWIGX)	0.47	-44.9

Note: Performance data as of April 22, 2009 / Source: Morningstar

The results of these 20 funds demonstrate that, while there is no one-to-one correspondence between lower fees and improved performance, there is a general tendency in that direction. In these examples, at least one low-expense fund outperformed the highest-expense example in each category.

These funds were chosen because each is among the biggest -- that is, the most widely held -- in its group. None was chosen because its expenses are outrageous; indeed, the most expensive fund in each group has lower expenses that the average fund in its category, according to Morningstar. Those averages range from 1.35% for large-capitalization growth funds to 1.57% for small-cap growth funds.

Finally, these funds were chosen because they are all mutual funds. In nearly every category, I could have cited examples of ETFs that perform much better than average while charging fees that are much, much lower.

Continued: Magellan's asset woes

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