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Why Mutual Funds Are Getting Cheaper to Own

Rob Silverblatt

As the mutual fund industry continues to recover from its lows during the recession, investors are benefitting not only from better returns, but also lower costs. According to new research from the Investment Company Institute (ICI), average expense ratios for a host of mutual fund categories decreased in 2012.

Among the biggest winners in 2012, at least from a cost perspective, were investors in target-date funds. The average target-date investor had an expense ratio of 0.58 percent in 2012, down from 0.61 percent in 2011. To put those numbers in context, expenses in target-date funds are down from an asset-weighted average of 0.67 percent in 2008.

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"Two factors likely played a role" in the downward pressure on target-date fund costs, according to the ICI report, entitled "Trends in the Expenses and Fees of Mutual Funds." "First, assets in target date mutual funds have tripled since 2008 ... Second, a greater concentration of assets in lower-cost target date mutual funds pushed down the average expenses of these funds."

Higher asset bases also helped drive down costs in equity funds. Lured by strong returns from the stock market, investors have been pouring their money back into equity funds. The more money funds have under management, the less they need to charge each individual investor. In 2012, the average investor in an equity fund paid an expense ratio of 0.77 percent, down from 0.79 percent in 2011. "Since 2008, we've had strong gains [and inflows] in these funds, and so the scale of the base of business has brought average expense ratios down," explains Todd Rosenbluth, a fund analyst at S&P Capital IQ.

[Read: 5 Lessons From the Last Stock Crash.]

Another factor driving down costs, and not just for equity funds, is competition from exchange-traded funds. ETFs are index products and tend to have lower fees than mutual funds. As ETFs have gained in popularity, mutual fund providers have felt pressure to cut expense ratios to stay competitive. "The pressure from ETFs is having an impact on what mutual fund companies do and whether the boards [of directors of the funds] choose to bring expense ratios down," says Rosenbluth.

Similarly, index mutual funds are getting cheaper as they compete against not only ETFs, but also other index mutual funds. "Investor demand for index funds is disproportionately concentrated in the very lowest cost funds," according to the ICI. "For example, in 2012, 61 percent of the assets of index equity funds were held in funds with expense ratios that were among the lowest 10 percent of all equity index funds."

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Although the changes in expenses from year to year are relatively small, the long-term picture painted by the ICI report should be encouraging to investors. "In 1993, investors on average incurred expenses of 107 basis points, or $1.07 for every $100 in assets, to invest in equity funds," according to the report. "By contrast, expenses averaged 77 basis points for equity fund investors in 2012, nearly 30 percent lower than in 1993. During that period (1993 to 2012), the expense ratios of bond funds dropped 27 percent to 61 basis points, while hybrid fund expense ratios went from 96 basis points to 79 basis points, an 18 percent decrease."

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