Fees on Mutual Funds Could Get Cheaper
Thursday, February 11, 2016

There is some good news for investors: The war on expenses is continuing. Vanguard recently filed with the Securities and Exchange Commission (SEC) to launch two funds with total annual operating expenses of 0.01%. That is not a typo; the expense ratio was copied and pasted directly from the SEC filing.

How cheap is 0.01%? To put it into terms that are easier to grasp, the annual expenses paid on every $1,000 invested in either fund will be $0.10. Yes, that’s 10 cents. On a $10,000 investment, you would pay $1.00 per year. On a $100,000 investment, you would pay a mere $100 to have professional management oversee your money. That’s extraordinarily cheap.

There is a caveat; after all, there’s never a completely free lunch on Wall Street. The minimum investment amount required to open and maintain a fund account for these “Institutional Select Shares” is generally $5 billion. The good news is that there is a loophole, so to speak. Individual investors whose employers offer a 401(k) plan through Vanguard may be able to access this share class of the Total Market Index and the S&P 500 Index funds for a considerably smaller amount. Those of you not eligible to buy these funds’ ultra-cheap share class may still benefit, however.

Expense ratios for exchange-traded funds tracking widely followed indexes have been falling. BlackRock and Vanguard in particular have been in a price war. In putting together this year’s mutual fund guide, we observed a trend of lower expense ratios for mutual funds as well. Among the large-cap domestic funds included in the print editions of this year’s and last year’s AAII Guide to the Top Mutual Funds, nearly half reduced their expense ratios. Some of the reductions were very small, but the trend was still down. We further observed a reduction in the average expense ratio for 57 out of the 71 fund categories we track. The latter comparison is not completely apples-to-apples because of some funds being added to or removed from a category, but the overall trend points to lower expense ratios. (The reduction for domestic large-cap funds I stated is based on an apples-to-apples comparison.)

What impact Vanguard’s latest filing will have on overall fund expenses remains to be seen, but it should bode well for investors. Every dollar saved on expenses is a dollar investors get to keep and grow. It should also put pressure on providers of active funds to justify their fees. This is particularly the case for the so-called closet indexers—actively managed funds whose portfolios mostly mimic an index.

Most importantly, the fee cut raises a big question that individual and institutional investors should always ask: What are we getting for our money? With costs so low, an active strategy should only be followed if it gets you something different than the index: better long-term returns, less volatility or more income. If you are not getting one of these three benefits over a period of several years, put your money into a broad market index fund and smile about your savings. (Make sure you make the judgement based on several years of return data since any fund manager can endure periods of underperformance over short periods of time.)

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The Week Ahead

The U.S. financial markets will be closed on Monday, in observance of Presidents Day. Our offices will be closed as well.

More than 50 members of the S&P 500 will report earnings next week. The only Dow Jones industrial average component in this group will be Wal-Mart Stores (WMT) on Thursday.

On the economic front, the February Empire State manufacturing survey will be released on Tuesday. Wednesday will feature January housing starts and building permits, the January Producer Price Index (PPI), January industrial production and capacity and the minutes from the January Federal Open Market Committee meeting. The February Philadelphia Federal Reserve survey will be released on Thursday. Friday will feature the January Consumer Price Index (CPI).

Three Federal Reserve officials will speak: Philadelphia president Patrick Harker on Tuesday, St. Louis president James Bullard on Wednesday and Cleveland president Loretta Mester on Friday.

The Treasury Department will auction $7 billion of 30-year inflation-adjusted securities (TIPS) on Wednesday.

February options will expire on Friday.

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AAII Sentiment Survey

Pessimism among individual investors about the short-term direction of stocks rebounded back to nearly 50% in the latest AAII Sentiment Survey. The rise occurred as optimism fell below 20% for the second time this year.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 8.3 percentage points to 19.2%. This is a four-week low. It is also the 11th consecutive week optimism has been below 30% and the 47th out of the past 49 weeks that bullish sentiment is below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 5.7 percentage points to 32.1%. The decline was not large enough to keep neutral sentiment from staying above its historical average of 31.0% for a second consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded by 14.0 percentage points to 48.7%. This matches the nearly three-year high set three weeks ago. The increase keeps pessimism above its historical average of 30.0% for a sixth consecutive week and for the eighth time in nine weeks.

Since 1990, bullish sentiment has been below 20% only eight times, including two occurrences this year. This week’s extraordinarily low level of optimism coincides with a retesting of the recent lows by both the S&P 500 and the Russell 2000. Contributing to the lack of optimism and the high level of pessimism are the slowing pace of economic growth in China, tensions in the Middle East, the pace of economic growth in the U.S., the rate of earnings growth and prevailing valuations. Some individual investors have increased their cash allocations, though there are others who view the recent downside volatility as a buying opportunity or are intending to buy should prices weaken further.

This week’s special question asked AAII members what industries or sectors they currently like. Nearly one-third of respondents (31%) said health care, including pharmaceutical and biotech companies. Technology was second, named by 18% of respondents. Slightly more than 14% of respondents said utilities. Gold and energy were tied for fourth with about 13% of respondents listing either (or some cases, both) industries. Several members named more than one preferred industry in their responses.

This week’s Sentiment Survey results:

Bullish: 19.2%, down 8.3 points
Neutral: 32.1%, down 5.7 points
Bearish: 48.7%, up 14.0 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!