Too few low cost mutual funds and ETFs


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Too few low cost mutual funds and ETFs – Far too many high cost funds

In screening and selecting low cost mutual funds and ETFs, you should understand this involves sorting and screening thousands of mutual funds and ETFs using databases from data vendors such as Morningstar and/or Lipper. It is shameful just how few low cost funds are available directly to investors. Nevertheless, the good news is that more mutual fund families are offering some low cost funds to meet the growing demand for them.

It is also shameful how large the number of excessively expensive mutual funds is – especially the proliferation of expensive funds available only through financial advisors. Through the randomness and volatility of chance outcomes, the mutual fund industry obscures its failure to demonstrate sustained investment management skill. Fund companies team up with industry-paid financial advisors who market only mutual fund “winners” to investors who have a penchant for chasing performance.

Every year, mutual fund companies introduce hundreds of new mutual funds with high expense ratios to see what will stick, and financial advisors push these funds. Do not expect the incredibly long list of expensive much funds to get shorter. Expensive mutual funds are very profitable to both fund companies and financial advisors. That is because far too many retail investors are such easy marks.

The good news is that when the “wheat” of low cost, broadly diversified, passively managed index investment funds has been separated from the 95%+ “chaff” of the financial industry’s self-serving mutual fund and ETF products, there are still plenty of attractive mutual fund and ETF choices for the individual investor. Usually, there are several vendors of these more attractive low cost index investment funds in either form of investment fund – mutual fund or ETF.

Vanguard and Fidelity

If you inspect screened lists of low cost mutual funds and ETFs, you will notice immediately that two vendors, Vanguard and Fidelity, have the greatest variety of very low cost options. In many situations, they are the only options available, unless you are willing to pay a much higher management expense ratio, which would seem difficult to justify. For example, on the various US Taxable Bond Mutual Fund lists in my book, Buyers Guide to Low Cost Mutual Funds, you will find 23 Vanguard bond mutual funds and 10 from Fidelity. Schwab has 3, T Rowe Price has 3, and four other taxable bond mutual fund families have one low cost bond mutual fund each.

Therefore, if you invest in low cost index mutual funds, you might find yourself maintaining accounts with Vanguard and/or Fidelity. You should note that Vanguard is the dominant low-cost mutual fund vendor, and Vanguard also offers ETFs. Until October of 2010, to get into Vanguard’s lowest cost mutual funds with the lowest retail management expense ratios (their “Admiral” share class) required a $50,000 or $100,000 minimum initial investment per fund. However, in October of 2010 these account minimums were lowered dramatically.

To the benefit of low-cost investors, in October 2010, Vanguard announced that its Admiral investment class minimums for most, but not all, of its Admiral funds would be reduced to $10,000. This makes the process of selecting a mix of the very lowest cost index funds much easier with Vanguard. Minimum investment requirements are usually $3,000 for other Vanguard “Investor” funds, when asset levels are below the Admiral minimums. These Investor share class funds still have low expenses, however.

Among Vanguard and Fidelity funds, look for their low cost, passively managed index mutual funds

Fidelity has fewer very low cost mutual fund offerings, but Fidelity does offer some of the lowest cost diversified mutual funds. Several years ago, Fidelity decided to compete directly with Vanguard with their own very low cost index funds. At the time, Fidelity’s CEO was quoted saying that Fidelity did not expect much profit from such low cost mutual funds. However, in effect, he said that Fidelity saw more profit opportunities in cross-selling their more expensive funds to new customers who had been attracted by their very low cost index funds.

Fidelity expected to capture some of the low cost market that Vanguard held, and they have. Once they have these new customers, Fidelity intends to entice them to invest in the more profitable and higher fee mutual funds that Fidelity has. If you decide to open a Fidelity account, I suggest that you keep your investments in their lowest cost funds and resist any Fidelity promotion for their more expensive funds – particularly, if the rationale is superior, but ephemeral,  historical performance.

Vanguard also offers higher cost, actively managed funds. Nevertheless, Vanguard’s lower cost index funds are preferable, when compared with Vanguards more expensive, actively managed funds – even though Vanguard’s actively managed funds carry expense ratios that are well below industry averages for comparable actively managed mutual funds.

A vast horde of investment fund companies compete in the mid- and high-cost range. While I have highlighted Vanguard and Fidelity in this discussion, because they offer numerous very low cost funds, there are a handful of other fund companies competing with Vanguard and Fidelity based on low costs and operational efficiency. You may wish to consider those other vendors, especially if you already have accounts with them and want to move your assets into their lower cost funds.

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