Limit Expenses To Boost Returns

9/20/2010


Cheaper is better when picking mutual funds.

A fund’s expense ratio is the percentage deducted each year to cover management and administrative costs. The average diversified U.S. stock fund charges 1.43%, meaning a shareholder would pay roughly $143 annually for every $10,000 invested.

Keeping a lid on fund expenses is vital. Several academic studies have documented the negative relationship between high expense ratios and future fund returns. In a Vanguard study, the cheapest funds in every asset class (large, midsize, and small stocks) averaged returns at least 2.7 percentage points higher than those of the most expensive funds from 1996 through 2005. In a study published in August, Morningstar, a leading provider of mutual-fund data, concluded that expenses are a strong and dependable predictor of performance. Furthermore, Morningstar said,“Investors should make expense ratios a primary test in fund selection.” Notably, 19 of our 20 recommended funds have expense ratios below category averages.

STANDOUT FUNDS WITH LOW EXPENSES
—– Exp. Ratio –—
Fund (Price; Ticker)
12-Mo.
Return
(%)
Fund
(%)
Category
Average
(%)
Fund
Score
Category
Dreyfus MidCap Index
($24; PESPX)
14.4
0.50
1.40
90
Midcap blend
Fidelity Blue Chip Growth
($39; FBGRX)
11.3
0.76
1.40
86
Large-cap growth
Fidelity Capital & Income
($9; FAGIX)
20.7
0.76
1.23
99
High-yield bond
Meridian Growth
($37; MERDX)
19.4
0.84
1.48
99
Midcap growth
T. Rowe Price Cap. Apprec.
($19; PRWCX)
9.9
0.75
1.46
96
Balanced bias
T. Rowe Price New Horiz.
($28; PRNHX)
18.0
0.85
1.61
97
Small-cap growth
Vanguard Equity-Income
($19; VEIPX)
11.0
0.36
1.32
97
Large-cap value
Vanguard GNMA
($11; VFIIX)
7.5
0.23
1.02
90
Inter.-term gov’t
Vanguard Interm.-Term
Bond ($12; VBIIX)
12.4
0.22
0.98
99
Inter.-term corp
Vang. Int’l Growth
($18; VWIGX)
9.0
0.53
1.51
96
Foreign blend
Vanguard Small Cap Index
($29; NAESX)
12.1
0.28
1.44
93
Small-cap blend
Vang. Wellesley Income
($22; VWINX)
12.3
0.31
1.42
99
Balanced bias

Expenses are an unavoidable drain on performance, but at least they are easily identifiable and controllable. Still, focusing only on expenses can be a mistake, so we look for low-cost funds with strong track records. The 12 funds listed above (including three Forecasts’ picks in bold) share these attributes:

Bargain-basement expenses. Based on annual expense ratios, all 12 funds rank among the cheapest 10% of their peer groups.

Outstanding scores in our fund-rating system. All 12 funds place among the top 15% of their peers based on category rank. Our ratings — at www.DowTheory.com/go/Funds — are calculated using seven measures related to total returns, expense ratios, tax efficiency, and risk-adjusted performance. Ratings are generated monthly for more than 3,700 funds.

Strong relative returns. All 12 funds rank among the top 40% of their categories for one- , three- , and five-year returns.

Fund change

Fidelity Export & Multinational ($19; FEXPX) is being dropped from our fund portfolios and being replaced with Buffalo Growth ($22; BUFGX).

FORECASTS FUND RECOMMENDATIONS
Through Sep. 14, our recommended Growth Portfolio has returned 4.2% for the year, versus 1.9% for its benchmark portfolio. The Conservative Portfolio has returned 4.4%, versus 3.0% for its benchmark.
— Year-to-Date —
—– % of Portfolio –—
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
American Century Heritage
($18; TWHIX)
10.5
A
8
9
86
Buffalo Growth
($22; BUFGX)
5.3
A
7
8
90
Dreyfus Small Cap Stock Index
($17; DISSX)
4.7
C
0
0
61
Fidelity Leveraged Co. Stock
($23; FLVCX)
1.9
E
0
0
40
Heartland Select Value
($25; HRSVX)
1.4
E
7
9
82
Heartland Value Plus
($25; HRVIX)
5.3
D
8
9
95
T. Rowe Price Int’l Discovery
($39; PRIDX)
6.5
D
5
6
71
T. Rowe Price New Horizons
($28; PRNHX)
9.9
A
8
9
97
Vanguard 500 Index
($104; VFINX)
1.9
B
5
5
60
Vanguard Dividend Growth
($13; VDIGX)
0.8
C
8
9
100
Vanguard Emerging Mkts.
Stock Indx. ($28; VEIEX)
6.5
C
0
5
86
Vanguard GNMA ($11; VFIIX)
6.5
C
5
0
90
Vanguard Inter.-Term Tax
Exempt ($14; VWITX)
5.6
C
0
0
78
Vanguard International Value
($30; VTRIX)
(1.4)
C
8
6
86
Vanguard Short-Term Invest.
Grade ($11; VFSTX)
4.9
B
0
0
79
Vanguard Total Bond Mkt. Index ($11; VBMFX)
7.2
D
15
0
79
Vanguard Total Int’l Stock
Index ($15; VGTSX)
1.4
B
6
6
93
Vanguard Wellesley Income
($22; VWINX)
7.8
A
0
6
99
Vanguard Wellington
($29; VWELX)
3.7
C
5
8
97
Wells Fargo Advantage High
Income ($7; STHYX)
9.0
C
5
5
53
* Year-to-date ranks through Sep. 14 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. Fund ratings are percentile ranks based on our fund-rating system.

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