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Fundamentals: INVESTMENT COMPANY INSTITUTE RESEARCH IN BRIEF

Professional investors often explicitly or implicitly claim to understand the fundamentals of finance theory. They may, for example, base allocation decisions on historical returns, volatility, correlations of returns across funds or asset classes, investment fees, industry outlooks, or various other financial metrics. Most 401(k) participants do not have access to much of that information or are poorly equipped to benefit from it. They may be guided by recent historical returns, which are typically readily available and understood, even if incorrectly so. Funds with higher returns understandably appear more attractive to investors. However, the finance literature. | Fundamentals INVESTMENT COMPANY INSTITUTE RESEARCH IN BRIEF Vol. 13 No. 1 February 2004 1401 H Street NW Suite 1200 Washington DC 20005 202 326-5800 www.ici.org Copyright 2004 by the Investment Company Institute The Cost of Buying and Owning Mutual Funds rt he Investment Company Institute ICI has published numerous studies on mutual fund fees and expenses since 1998. These studies have shown that the cost of sales loads and annual expenses paid by mutual fund shareholders has dropped sharply since 1980 and that funds pass along cost savings achieved from scale economies.1 Furthermore the U.S. Securities and Exchange Commission SEC has concluded that large funds generally have lower expense ratios than do small funds 2 and a General Accounting Office GAO study found that for a group of large stock and bond funds fees fell for a large majority of those that had asset growth.3 Nonetheless the conventional wisdom persists that the cost that shareholders pay for investing in mutual funds is rising and that shareholders have not benefited from the scale economies as their funds experienced growth. This issue of Fundamentals examines these misperceptions about fund fees which have arisen in large part because industry analysts often ignore the structural changes that the mutual fund industry has undergone during the past two decades. One frequently overlooked change is the means by which fund shareholders pay for advice and service from brokers and other financial advisers. Fund shareholders rely less on sales loads and more on annual 12b-1 fees to pay for these services than even ten years ago. Because most analysts ignore this development they fail to realize that the increase in 12b-1 fees has been offset by the drop in sales loads paid by fund shareholders. Another significant but overlooked change is a 20-fold increase in the number of fund shareholders since 1980. Industry analysts often focus on the growth in assets but fail to recognize that the expansion in the .