About the intelligent investor
The weekly column of ‘The Intelligent Investor’ by Jason Zweig, has been published in the Wall Street Journal for about a decade and is published exclusively in Globes. According to Zweig: “My goal is to help you distinguish between the good advice and the one that just sounds good”
About Jason Zweig
One of the senior journalists of The Wall Street Journal. Author of the book “Your Money and Your Mind: How Neuroscience Can Help You Get Rich”, and the editor of the updated version of the bestseller “The Intelligent Investor”, described by Warren Buffett as “the best investment book ever written”
It’s time for revenge. Not only savings account holders suffered from the low interest rate for most of a period that lasted a little more than a decade. Some property managers suffered from this too – but those days are over.
The Federal Reserve cut short-term interest rates sharply in 2008 – leaving them close to zero, except for a brief respite, until early this year.
When interest rates were so low, asset managers had no choice but to waive most of the management fees they used to charge for managing financial funds. Otherwise, investors would often receive a negative return after fees are collected.
Between 2009 and 2021, asset management firms will forgo more than $53 billion in such fees, according to the Investment Company Institute. Now they are rushing to recoup the lost management fees. And that hurts the return for investors.
At the end of 2021, no U.S. money fund was charging more than 0.18% a year, according to Crane Data, a Westboro, Mass.-based firm that tracks money funds and other cash investments.
As of Sept. 30, 210 mutual funds — a quarter of them — charge at least 0.5 percent in annual management fees, according to Crane. More than 20 charge 1% or more.
That helps explain why, while one-month Treasury bonds and commercial paper yielded about 3.2% this week, the yield on the average money fund was just under 2.8%.
Of course, that’s much better than the paltry 0.02% that mutual funds gave on December 31st. But it’s not good enough.
Comparison between monetary funds and other funds
Let’s put the costs into perspective by comparing mutual funds to other types of funds.
At that time in the 1990s, total management fees in mutual funds of stocks averaged 1%. To date, the management fees for stock funds have dropped significantly, due to the intense competitive pressure from the Vanguard Group, the index fund giant, and from cheap basket funds.
Calculated by size, equity funds earned an average of 0.47% per year in 2021, according to the Investment Company Institute. Equity mutual funds were even cheaper, charging an average of 0.16%.
What happened during this period to the financial funds? In 2008, taxable mutual funds charged an average management fee of 0.48 percent a year, and the 100 largest charged an average of 0.37 percent, according to Crane. As of September 30 this year, the average management fee was 0.39% in all taxable financial funds, and 0.26% in the calculation of the 100 largest.
Instead of falling by more than half, like the commissions on stock funds, expenses on financial funds fell by less than a third – thanks to their steep increase this year.
Although the portfolios of these funds tend to look similar, mutual funds still select each and every investment individually, and do not passively replicate an entire market, as stock and bond funds do. This means that their trading costs are relatively high.
Financial funds that charge higher management fees probably return lower net returns. Those with an annual expense of at least 0.5% return an average return of 2.18%, compared to 2.76% for the 100 largest mutual funds.
Possibility of taking risk to balance the management fee
All other things being equal, funds that charge higher fees must produce a lower return—unless fund managers take special risks to try to offset the burden of increased management fees.
On average, the funds that charge commissions higher than 0.5% hold securities with a 10% longer validity – 18 days compared to 16 days in the calculation of all financial funds.
This makes those charging the highest management fees slightly riskier.
Staying away from these financial funds will reduce not only the costs for you, but also the risk.
The recent increase in interest rates raises a bigger question: is it even worth holding money funds?
There are still $4.58 trillion in such funds. Among other things, it is because they are comfortable. Receive free check service, transfers to and from the bank, exchanges to and from other mutual funds and withdrawals at any time without penalty.
However, financial advisors may themselves charge an annual management fee on cash you hold in a mutual fund – something they often don’t do on Treasury bond holdings or bank certificates of deposit.
This stream of commissions may incentivize them to recommend a certain fund, or to leave it as it is, even if it is not the best option for you.
Stock trading companies take even more of your little money. So-called sweep options, in which a securities trading company automatically routes any money you earn from interest, dividends or sales, often give a return of less than 0.5%.
Banks, brokers and investment houses rely on you to leave your money where it is, and this allows mutual funds to remain one of the last bastions of high fees.
You may need to keep some cash in mutual funds for convenience.
But you can increase your return on cash to more than 3% by buying Treasury bonds directly, investing in corporate debt from online banks, or using an asset rating service like MaxMyInterest.com.