It's easy to overlook what's important when it comes to saving money. Many people would sooner clip a coupon for shampoo than review the expenses they're paying to invest in mutual funds.
Cost is hardly the only consideration because a fund charging above-average fees may generate larger returns than a low-cost fund. But more often than not, any performance edge that a fund manager achieves is erased by the fees that are shaved off investors' returns.
The bottom line: Fees matter, especially when it's a product like mutual funds, which most investors will own for decades as they save for retirement.
The good news is that costs continue to come down. Fund expenses fell slightly last year, extending a long-term trend, according to an annual update Thursday from the Investment Company Institute, a trade organization.
Yet the findings show there are plenty of areas where the industry could be doing more to reduce the costs that investors pay.
Stock fund investors paid an average expense ratio of 0.77 percent last year. In dollar terms, that's $77 shaved from the return earned by a $10,000 investment in a fund. That's down from 0.79 percent in 2011 and 0.83 percent in 2010. Going back further, the progress has been even more impressive. Expenses averaged 1.07 percent in 1993.
Those are the ongoing expenses paid out of the fund's assets to cover operating costs, expressed as a percentage of total assets. Each shareholder indirectly pays a proportional share of overall costs via the expense ratio, with the amount paid based on average fund assets over the course of a year. The size of the expense ratio determines how much money an investor earns from a fund's investment returns.
To calculate average fees across thousands of funds, the ICI compared each fund's expense ratio with its end-of-the-year asset total. The averages are asset-weighted.
In addition to stock funds, expenses declined at bond funds and mixed-asset funds that invest in stocks and bonds. But it's clear the industry needs to do more to keep investors' costs down. Here are four areas meriting special attention:
LITTLE PROGRESS FOR BOND FUNDS
Average expenses at bond funds slipped to 0.61 percent from 0.62 in 2011, and 0.64 in 2010. Ten years ago, the average was 0.83 percent. Although that's a positive trend, the decreases in recent years have been surprisingly small, says Todd Rosenbluth, a fund analyst with S&P Capital IQ.
Assets in bond funds have more than doubled since 2008, to about $3.5 trillion. It's unlikely that costs to manage those funds have doubled.
The larger the fund's asset total, the larger the revenue from fees. The more profitable a fund is to run, the easier it is to cut fees without hurting the bottom line.
SLOWING RATE OF IMPROVEMENT
Last year's 0.02 percentage point decline in the average stock fund expense was just half the size of the 0.04 point decreases in 2011 and 2010.
One reason progress has been slow is that investors have been withdrawing more cash from U.S. stock funds in recent years than they've deposited into them. With cash flowing out, it's hard to cut fees.
Yet that impact would have been greater if not for the market rally that started in early 2009.
SLOW PROGRESS FOR MANAGED FUNDS
A key reason that investors have been pulling cash from managed stock funds in recent years while adding to index funds is the cost differential. Managed stock funds charged an average 0.92 percent last year, or nearly seven times more than the 0.13 percent average for index funds.
MANY FUNDS ARE PRICEY, DESPITE SIZE
Research by S&P Capital IQ identifies several large funds that continue to charge above-average fees, despite the cost-efficiency one might expect.