RP: Fees and charges are a key consideration when choosing a fund to invest in. Research by Morningstar has shown that it’s the most important predictor of a fund’s future returns. Thankfully, fund fees are coming down, and you might have thought costs would be less important as a result. In fact, the data shows quite the opposite. Jeff Ptak is Morningstar’s Global Director of Manager Research.
JP: One of the chief explanations for why one fund performs better than another fund is the expense-disparity between them. If we can posit the argument that in the past there was a wider range of expenses, then it stood to reason that costs played a significant role in performance differences between funds. It is one of the reasons why cost works as well as a predictor as it has done. But if costs are converging towards a common point, that being zero, the question for me became - are they going to be as good of a sorting mechanism as they were? Essentially, what we found is, it’s just the opposite. They have not lost any of their predictiveness or at least significance in explaining performance differences. They loom larger.
RP: So, why should it be that, despite falling fund fees, cost is even more important than it was? The answer, says Morningstar, is that funds are performing more alike.
JP: The pre-fee performance difference between funds in a given category of a given style has actually narrowed. It has narrowed more quickly than the expense disparities have narrowed. So essentially, what it means is, that the cost differences are looming even larger right now than they had even in the past.
RP: So, it’s even more critical than before to work out exactly how much you’re paying to invest. And remember — some costs are hidden, or at least very hard to find. Working with an adviser who really understands this subject will give you a huge advantage.
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