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Mutual fund investors, like investors in all financial products, pay for services they receive. This chapter provides an overview of mutual fund expenses and fees.

Mutual funds provide investors with many investment-related services, and for those services investors incur two primary types of expenses and fees: ongoing expenses and sales loads. Average expenses paid by mutual fund investors have fallen substantially. For example, on an asset-weighted basis, average expense ratios for equity funds fell from 99 basis points in 2000 to 74 basis points in 2013, a 25 percent decline.

Trends in Mutual Fund Expenses

Mutual fund investors incur two primary types of expenses and fees: ongoing expenses and sales loads. Ongoing expenses cover portfolio management, fund administration, daily fund accounting and pricing, shareholder services (such as call centers and websites), distribution charges (known as 12b-1 fees), and other operating costs. These expenses are included in a fund’s expense ratio—the fund’s annual expenses expressed as a percentage of its assets. Since expenses are paid from fund assets, investors pay these expenses indirectly. Sales loads are paid at the time of share purchase (front-end loads), when shares are redeemed (back-end loads), or over time (level loads).

On an asset-weighted basis, average expense ratios* incurred by mutual fund investors have fallen substantially (Figure 5.1). In 2000, equity fund investors incurred expense ratios of 99 basis points, on average, or 99 cents for every $100 invested. By 2013, that average had fallen to 74 basis points, a decline of 25 percent. Hybrid and bond fund ratios also have declined. The average hybrid fund expense ratio fell from 89 basis points in 2000 to 80 basis points in 2013, a reduction of 10 percent. In addition, the average bond fund expense ratio fell from 76 basis points in 2000 to 61 basis points in 2013, a decline of nearly 20 percent.

* In this chapter, unless otherwise noted, average expenses are calculated on an asset-weighted basis.
Basis points simplify percentages written in decimal form. A basis point equals one-hundredth of 1 percent (0.01 percent), so 100 basis points equals 1 percentage point. When applied to $1.00, 1 basis point equals $0.0001; 100 basis points equals one cent ($0.01)..

Figure 5.1

Expenses Incurred by Mutual Fund Investors Have Declined Substantially Since 2000

Basis points, 2000–2013

Figure 5.1

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Note: Expense ratios are measured as asset-weighted averages. Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

Understanding the Decline in Fund Expense Ratios

Several factors account for the steep drop in expense ratios. First, expense ratios often vary inversely with fund assets. Some fund costs included in expense ratios—such as transfer agency fees, accounting and audit fees, and directors’ fees—are more or less fixed in dollar terms regardless of fund size. That means that when a fund’s assets rise, these relatively fixed costs make up a smaller proportion of the fund’s assets. But when a fund’s assets fall, these fixed costs make up a greater proportion of a fund’s assets. Thus, if the assets of a fixed sample of funds rise over time, the sample’s average expense ratio tends to fall (Figure 5.2).

Figure 5.2

Mutual Fund Expense Ratios Tend to Fall as Fund Total Net Assets Rise

Share classes of domestic equity mutual funds continuously in existence since 20001

Figure 5.2

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1Calculations are based on a fixed sample of share classes. Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
2
Expense ratios are measured as asset-weighted averages.
Sources: Investment Company Institute and Lipper

Another factor in the decline of the average expenses of long-term funds is the shift toward no-load share classes,* particularly institutional no-load share classes, which tend to have below-average expense ratios. In part, this is because of a change in how investors pay for services from brokers and other financial professionals (see Mutual Fund Load Fees).

Mutual fund expenses also have fallen because of economies of scale and competition. Investor demand for mutual fund services has increased dramatically in recent years. From 1990 to 2013, the number of households owning mutual funds more than doubled—from 23.4 million to 56.7 million. Over the same period, the number of shareholder accounts more than quadrupled—from 61.9 million to 264.8 million. Such sharp increases in demand would, by themselves, tend to boost fund expense ratios. Any such tendency, however, was mitigated by downward pressure on expense ratios—from competition among existing fund sponsors, new fund sponsors entering the industry, competition from products like exchange-traded funds (ETFs) (see chapter 3), and economies of scale resulting from the growth in fund assets.

* See no-load share classes.

Figure 5.3

Fund Shareholders Paid Below-Average Expenses for Equity Funds

Basis points, 2000–2013

Figure 5.3

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Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

Finally, shareholders tend to invest in funds with below-average expense ratios (Figure 5.3). The simple average expense ratio of equity funds (the average for all equity funds offered for sale) was 137 basis points in 2013. The asset-weighted average expense ratio for equity funds (the average shareholders actually paid) was far lower—just 74 basis points.

Another way to illustrate this tendency is to examine how investors allocate their assets across funds. At year-end 2013, equity funds with expense ratios in the lowest quartile held 73 percent of equity funds’ total net assets, while those with expense ratios in the upper three quartiles held only 27 percent (Figure 5.4). This pattern holds for actively managed equity funds, index equity funds, and target date funds (funds that adjust their portfolios, typically more toward fixed income, as the fund approaches and passes its “target date”). Index equity funds with expense ratios in the lowest quartile held 72 percent of index equity fund assets at year-end 2013. Similarly, target date funds with expense ratios in the lowest quartile held 74 percent of target date fund assets.

Figure 5.4

Assets Are Concentrated in Lower-Cost Funds

Percentage of total net assets, 2013

Figure 5.4

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1 Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
2
Data include the full universe of target date funds, 97 percent of which invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

Index Mutual Fund Expenses

Growth in index mutual funds has contributed to the decline in equity and bond fund expense ratios.* Index fund assets have grown substantially in recent years—indeed, more than quadrupled—from $384 billion in 2000 to $1.7 trillion in 2013 (Figure 5.5). Investor demand for index bond and hybrid funds has grown in the past few years, but 82 percent of index fund assets are invested in index equity funds.

* Unless otherwise noted, the discussion and figures in this section exclude exchange-traded funds (ETFs), which are examined separately in chapter 3.

Index funds tend to have lower-than-average expense ratios for several reasons. The first is their approach to portfolio management. An index fund generally seeks to mimic the returns on a given index. Under this approach, often referred to as passive management, portfolio managers buy and hold all, or a representative sample of, the securities in their target indexes.

Figure 5.5

Total Net Assets and Number of Index Mutual Funds Have Increased
in Recent Years

Billions of dollars, 2000–2013

Figure 5.5

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Note: Data exclude mutual funds that invest primarily in other mutual funds.

By contrast, under an active management approach, managers have more discretion to increase or reduce their exposure to the sectors or securities in their investment mandates. This approach offers investors the chance to enjoy superior returns. However, it also entails more-intensive analysis of securities or sectors, which can be costly.

A second reason index funds tend to have below-average expense ratios is their investment focus. Historically, the assets of index equity funds have been concentrated most heavily in “large-cap blend” funds that target U.S. large-cap indexes, notably the S&P 500. Assets of actively managed funds, on the other hand, have been more spread across stocks of varying levels of market-cap, international regions, or specialized business sectors. Managing portfolios of mid- or small-cap, international, or sector stocks is generally acknowledged to be more expensive than managing portfolios of U.S. large-cap stocks.

Third, index funds are larger on average than actively managed funds, which helps reduce fund expense ratios through economies of scale. In 2013, the average index equity fund had more than $4.4 billion in assets, nearly triple the $1.5 billion for the average actively managed equity fund.

Finally, index fund investors who hire financial professionals might pay for that service out of pocket, rather than through the fund’s expense ratio. Actively managed funds more commonly bundle those costs in the fund’s expense ratio.

These reasons, among others, help explain why index funds generally have lower expense ratios than actively managed funds (Figure 5.6). Note, however, that both index and actively managed funds have contributed to the decline in mutual funds’ overall average expense ratios shown in Figure 5.1. The average expense ratios incurred by investors in both index and actively managed funds have fallen—and by roughly the same amount. Indeed, from 2000 to 2013 the average expense ratio of index equity funds fell 15 basis points, similar to the decline of 17 basis points in the expenses of actively managed equity funds (Figure 5.6). Over the same period, the average expense ratio of index bond funds and actively managed bond funds fell 10 basis points and 13 basis points, respectively.

Figure 5.6

Expense Ratios of Actively Managed and Index Funds

Basis points, 2000–2013

Figure 5.6

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Note: Expense ratios are measured as asset-weighted averages. Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

In part, the downward trend in the average expense ratios of both index and actively managed funds reflects investors’ tendency to buy lower-cost funds. Investor demand for index funds is disproportionately concentrated in the very lowest-cost funds. In 2013, for example, 66 percent of index equity fund assets were held in funds with expense ratios that were among the lowest 10 percent of all index equity funds. This phenomenon is not unique to index funds, however. The proportion of assets in the lowest-cost actively managed funds is also high.

Understanding Differences in the Expense Ratios of Mutual Funds

Like the prices of most goods and services, the expenses of individual mutual funds differ considerably across the array of available products. The expense ratios of individual funds depend on many factors, including investment objective, fund assets, balances in shareholder accounts, and payments to intermediaries.

Fund Investment Objective

Fund expenses vary by investment objective (Figure 5.7). For example, bond and money market funds tend to have lower expense ratios than equity funds. Among equity funds, expense ratios tend to be higher for funds that specialize in sectors—such as healthcare or real estate—or those that invest in international stocks, because such funds tend to cost more to manage.

Figure 5.7

Expense Ratios for Selected Investment Objectives

Basis points, 2013

Investment objective 10th percentile Median 90th percentile Asset-weighted average Simple average
Equity funds1 74 129 213 74 137
   Growth 77 125 204 85 132
   Sector 80 137 221 83 144
   Alternative Strategies 125 177 276 135 188
   Value 75 121 200 83 129
   Blend 47 111 194 50 116
   World 90 142 225 90 151
Hybrid funds1 64 116 198 80 125
Bond funds1 49 88 167 61 100
   Taxable 48 90 173 62 102
   Municipal 50 80 157 57 95
Money market funds1 10 16 27 17 17
Target date funds2 50 101 167 58 104

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1 Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
2 Data include the full universe of target date funds, 97 percent of which invest primarily in other mutual funds.
Note: Data include index mutual funds but exclude exchange-traded funds.
Sources: Investment Company Institute and Lipper

Even within a particular investment objective, fund expense ratios can vary considerably. For example, 10 percent of equity funds that focus on growth stocks have expense ratios of 77 basis points or less, while another 10 percent have expense ratios of 204 basis points or more. This variation reflects, among other things, the fact that some growth funds focus more on small- or mid-cap stocks and others focus more on large-cap stocks. This is important because portfolios of small- and mid-cap stocks tend to cost more to manage.

Fund Size and Fund Average Account Size

Fund size and fund average account size also help explain differences in fund expense ratios. These two factors vary widely across the industry. In 2013, the median long-term mutual fund had assets of $310 million (Figure 5.8). Twenty-five percent of all long-term funds had assets of $77 million or less, while another 25 percent had about $1.2 billion or more. Average account balances show similar variation. In 2013, 50 percent of long-term funds had average account balances of $73,660 or less, 25 percent had average account balances of $27,815 or less, and 25 percent had average account balances of $256,082 or more.

Figure 5.8

Fund Sizes and Average Account Balances Varied Widely in 2013

Equity, hybrid, and bond funds,1 2013

  Fund assets
Millions of dollars
Average account balance2
Dollars
10th percentile $21 $14,794
25th percentile 77 27,815
Median 310 73,660
75th percentile 1,194 256,082
90th percentile 3,584 1,790,944

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1 Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
2 The average account balance is calculated at the fund level as total fund assets divided by the total number of shareholder accounts, which include a mix of individual and omnibus accounts.

Larger mutual funds tend to have below-average expense ratios because of economies of scale. Funds with higher average account balances also tend to have lower expense ratios than other funds. This reflects the fact that each account, regardless of its size, requires some of the same basic services (such as mailing account statements to account holders). Funds that cater primarily to institutional investors—who typically invest large amounts of money—tend to have higher average account balances. Funds that primarily serve retail investors typically have lower average account balances.

Mutual Fund Fee Structures

Mutual funds often are classified by the class of shares that fund sponsors offer, primarily load or no-load classes. Load classes generally serve investors who buy shares through financial professionals; no-load classes usually serve investors who buy shares without the assistance of a financial professional or who choose to compensate their financial professional separately. Funds sold through financial professionals typically offer more than one share class in order to provide investors with alternative ways to pay for financial services.

12b-1 Fees

Since 1980, when the U.S. Securities and Exchange Commission adopted Rule 12b-1 under the Investment Company Act of 1940, funds and their shareholders have had the flexibility to compensate financial professionals and other financial intermediaries through asset-based fees. These distribution fees, known as 12b-1 fees, enable investors to pay indirectly for some or all of the services they receive from financial professionals (such as their broker) and other financial intermediaries (such as retirement plan recordkeepers and discount brokerage firms). 12b-1 fees also can be used to pay for a fund’s advertising and marketing, but these uses are minimal in practice.

Load Share Classes

Load share classes include a sales load, a 12b-1 fee, or both. Sales loads and 12b-1 fees are used to compensate brokers and other financial professionals for their services.

Front-end load shares, which are predominantly Class A shares, were the traditional way investors compensated financial professionals for assistance. These shares generally charge a sales load—a percentage of the sales price or offering price—at the time of purchase. They also generally have a 12b-1 fee, often 0.25 percent (25 basis points). Front-end load shares are sometimes used in employer-sponsored retirement plans, but fund sponsors typically waive the sales load for purchases made through such retirement plans. Additionally, front-end load fees often decline as the size of an investor’s initial purchase rises (called breakpoint discounts), and many fund providers offer discounted load fees when an investor has total balances exceeding a given amount in that provider’s funds (called rights of accumulation).

Back-end load shares, which are primarily Class B shares, typically do not have a front-end load. Investors using back-end load shares pay for services provided by financial professionals through a combination of an annual 12b-1 fee and a contingent deferred sales load (CDSL). The CDSL is paid if fund shares are redeemed before a given number of years of ownership. Back-end load shares usually convert after a specified number of years to a share class with a lower 12b-1 fee (for example, Class A shares). In part because of this conversion feature, the assets in back-end load shares have declined substantially in recent years.

Level-load shares, which include Class C shares, generally do not have front-end loads. Investors in this share class compensate financial advisers with an annual 12b-1 fee (typically 1 percent) and a CDSL (also typically 1 percent) that shareholders pay if they sell their shares within a year of purchase.

No-Load Share Classes

No-load share classes have no front-end load or CDSL, and have a 12b-1 fee of 0.25 percent (25 basis points) or less. Originally, no-load share classes were sold directly by mutual fund sponsors to investors. Now, investors can purchase no-load funds through employer-sponsored retirement plans, mutual fund supermarkets, discount brokerage firms, and bank trust departments, as well as directly from mutual fund sponsors. Some financial professionals who charge investors separately for their services, rather than through a load or 12b-1 fee, use no-load share classes.

Mutual Fund Load Fees

Many mutual fund investors engage an investment professional, such as a broker, an investment adviser, or a financial planner. Among households owning mutual fund shares outside employer-sponsored retirement plans, 81 percent own fund shares through investment professionals. These professionals can provide many benefits to investors, such as helping them identify financial goals, analyzing an existing financial portfolio, determining an appropriate asset allocation, and (depending on the type of financial professional) providing investment advice or recommendations to help investors achieve their financial goals. The investment professional also may provide ongoing services, such as responding to investors’ inquiries or periodically reviewing and rebalancing their portfolios.

Thirty years ago, fund shareholders usually compensated financial advisers through a front-end load—a one-time, up-front payment for current and future services. That structure has since changed significantly.

One important element in the changing distribution structure has been a marked decline in load fees paid by mutual fund investors. The maximum front-end load fee that shareholders might pay for investing in mutual funds has changed little since 1990 (Figure 5.9). But front-end load fees that investors actually paid have declined markedly, from nearly 4 percent in 1990 to 1 percent or less in 2013. This in part reflects the increasing role of mutual funds in helping investors save for retirement. Funds that normally charge front-end load fees often waive load fees on purchases made through defined contribution plans, such as 401(k) plans. Also, front-end load funds offer volume discounts, waiving or reducing load fees for large initial or cumulative purchases (see Mutual Fund Fee Structures).

Figure 5.9

Front-End Sales Loads That Investors Pay Are Well Below the Maximum Front-End Sales Loads That Funds Charge

Percentage of purchase amount, selected years

  Maximum front-end sales load1 Average front-end sales load that
investors actually paid2
  Equity Hybrid Bond Equity Hybrid Bond
1990 5.0 5.0 4.6 3.9 3.8 3.5
1995 4.8 4.7 4.1 2.5 2.4 2.1
2000 5.2 5.1 4.2 1.4 1.4 1.1
2005 5.3 5.3 4.0 1.3 1.3 1.0
2010 5.4 5.2 3.9 1.0 1.0 0.8
2013 5.3 5.2 3.8 1.0 1.0 0.7

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1 The maximum front-end sales load is a simple average of the highest front-end load that funds may charge as set forth in their prospectuses.
2 The average front-end sales load that investors actually paid is the total front-end sales loads that funds collected divided by the total maximum loads that the funds could have collected based on their new sales that year. This ratio is then multiplied by each fund’s maximum sales load. The resulting value is then averaged (simple average) across all funds.
Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Strategic Insight Simfund

Another important element in the changing distribution structure of mutual funds has been a shift toward asset-based fees, which are assessed as a percentage of the assets that the financial professional helps an investor manage. Over time, brokers and other financial professionals who sell mutual funds have increasingly been compensated through these fees. An investor may pay an asset-based fee indirectly through a fund’s 12b-1 fee, which is included in the fund’s expense ratio, or directly (out-of-pocket) to the financial professional.

In part because of the shift toward asset-based fees (either through the fund or out-of-pocket), the market shares of front-end and back-end load share classes have declined in recent years, while those in level load and no-load share classes have increased substantially. For example, front-end and back-end load share classes saw net outflows totaling $559 billion (Figure 5.10) and saw their share of long-term mutual fund assets fall from 31 percent to 18 percent from year-end 2004 to year-end 2013 (Figure 5.11).

By contrast, level load and no-load share classes have seen net inflows and rising assets over the past 10 years. Although demand for level load share classes, which have a 12b-1 fee of at least 0.25 percent of assets, has weakened in recent years, these funds have seen modest inflows over the last decade. No-load share classes have accumulated the bulk of the inflows to long-term funds in the past 10 years. In 2013, no-load share classes accounted for 64 percent of long-term fund assets, up from 49 percent in 2004.

Figure 5.10

Nearly All Net New Cash Flow Was in No-Load Institutional Share Classes

Billions of dollars, 2004–2013

  2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
All long-term mutual funds $210 $192 $227 $224 -$225 $389 $241 $26 $196 $152
   Load 42 22 30 10 -151 15 -60 -133 -83 -71
      Front-end load1 48 41 44 18 -105 2 -57 -101 -67 -58
      Back-end load2 -40 -47 -47 -42 -39 -24 -27 -23 -16 -11
      Level load3 32 29 34 37 -9 36 22 -10 1 -8
      Other load4 1 0 0 0 1 0 2 0 -1 0
      Unclassified 1 -1 -1 -2 0 0 0 0 0 6
   No-load5 132 152 173 190 -48 345 293 181 307 277
      Retail 103 80 89 84 -77 159 86 -30 32 58
      Institutional 29 72 84 106 29 186 208 211 275 219
   Variable annuities 36 18 24 25 -26 29 8 -21 -28 -53

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1 Front-end load > 1 percent. Primarily includes Class A shares; includes sales where front-end loads are waived.
2 Front-end load = 0 percent and contingent deferred sales load (CDSL) > 2 percent. Primarily includes Class B shares.
3
Front-end load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 fee > 0.25 percent. Primarily includes Class C shares; excludes institutional share classes.
4
All other load share classes not classified as front-end load, back-end load, or level load. Primarily includes retirement share classes, known as Class R shares.
5 Front-end load = 0 percent, CDSL = 0 percent, and 12b-1 fee ≤ 0.25 percent.
Note: Components may not add to the totals because of rounding. Data exclude mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

Figure 5.11

Total Net Assets of Long-Term Mutual Funds Are Concentrated in No-Load Share Classes

Billions of dollars, 2004–2013

  2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
All long-term mutual funds $6,194 $6,864 $8,059 $8,914 $5,770 $7,797 $9,027 $8,935 $10,350 $12,299
   Load 2,197 2,347 2,683 2,864 1,770 2,253 2,440 2,254 2,435 2,769
      Front-end load1 1,570 1,728 2,026 2,190 1,374 1,749 1,881 1,749 1,890 2,144
      Back-end load2 334 271 241 204 102 98 78 50 39 32
      Level load3 275 322 392 448 284 396 459 438 493 568
      Other load4 16 17 15 10 8 8 18 16 11 16
      Unclassified 2 9 8 13 2 2 4 2 2 8
   No-load5 3,056 3,478 4,152 4,705 3,147 4,413 5,297 5,431 6,519 7,917
      Retail 2,199 2,452 2,875 3,205 2,030 2,820 3,280 3,203 3,733 4,484
      Institutional 857 1,026 1,276 1,500 1,117 1,592 2,016 2,228 2,787 3,433
   Variable annuities 941 1,039 1,225 1,346 854 1,131 1,291 1,250 1,396 1,614

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1Front-end load > 1 percent. Primarily includes A shares; includes sales where front-end loads are waived.
2Front-end load = 0 percent and CDSL > 2 percent. Primarily includes B shares.
3Front-end load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 fee > 0.25 percent. Primarily includes C shares; excludes institutional share classes.
4All other load share classes not classified as front-end load, back-end load, or level load. Primarily includes retirement share classes known as R shares.
5Front-end load = 0 percent, CDSL = 0 percent, and 12b-1 fee ≤ 0.25 percent.
Note: Components may not add to the total because of rounding. Data exclude mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Lipper

Some of the shift toward no-load share classes can be attributed to “do-it-yourself” investors. However, much of the shift represents sales through defined contribution plans as well as sales of no-load share classes through sales channels that compensate financial professionals with asset-based fees outside of funds (for example, mutual fund supermarkets, discount brokers, fee-based advisers, full-service brokerage platforms).