Low Fees Outshine Fund Star System: link

‘Morningstar’s director of mutual fund research, Russel Kinnel, reports in an August 9 [2010] article on Morningstar.com, How Expense Ratios and Star Ratings Predict Success: “In every single time period and data point tested, low-cost funds beat high-cost funds.” The study shows that using low fees as a guide would give investors better results than even Morningstar’s own star-rating system, which looks at past risk- and load-adjusted returns. While the stars system has typically guided investors to better results, it isn’t as effective in predicting future returns at times of big market swings. Low-cost funds performed better on average than high-cost funds, Morningstar found.’

Many bundled 401(k) plans offered to small companies have very large mutual fund fees. Fees average about 1.5% but at the high end of the spectrum fees can reach as much as 4%. These AUM (assets under management) fees always grow as your account grows. The compounded cost of these fees can reach into hundreds of thousands of dollars for a typical 401(k) account. The good news for a small business owner is that they do not have to pick a plan with high fees – much better lower cost alternatives are available. If your company has a 401(k) plan with high fees, consider opening your own IRA and contributing only enough into your 401(k) to get company match. You can also try to get your co-workers together and lobby the company to give you access to low cost index funds. There is often an option to invest in a stable value fund which shouldn’t cost much, and invest in low cost mutual funds in an IRA. Many small companies using bundled plans typically pass the fees on to the employees, so it is important to read your statement and understand what you are paying in 401(k) fees every year in addition to management fees charged by each individual fund.

Even with a low 5% compounded growth assumption, high fee accounts are going to be short by as much as hundreds of thousands compared to low cost accounts. Always make sure you understand what the total cost is that you are paying for your investments.