Mutual Fund Companies Thankful for the $1 Trillion
November 21, 2008
By Max Rottersman

HANOVER, NH (ETFguide.com) - In the late 1990s, you started saving through mutual funds.  So did everyone else.  Ten years later, the fund industry is collecting $70 billion a year, in fees, on the same 50 million households.  Should you ever attend an Investment Company Institute (ICI) conference, the trade group for the industry, the phrase, 'fat, dumb and happy'  might cross your mind.  

It now seems every executive on Wall Street has walked away with ample savings, while you're left behind with an empty bag.   They've been blaming it on sub-prime mortgages.  I heard a speaker at an ICI conference say that their analysts knew for years about the sub-prime problem, but once the companies in their fund portfolios, like Bear Sterns and Lehman, started buying them, what could they do?  Turn a blind eye and collect their fees it turns out.       

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In short, mutual fund managers profit because during a bull market you're so excited about your gains that you forgive them their fees, and too depressed in bear markets to make any changes.  

We'll look at some mutual fund fee data from FundAnalyze.

Last year Americans paid management fees of $50 billion.  For every dollar you paid in custody fees (to keep your assets safe) you paid $50 to have someone buy and sell stocks with no promise that it will come out good for you (the same promise made to every other American).  Over ten years that's $500 billion.  But it doesn't stop there.  You're also compensating your financial advisor who "helped" you, or your company's 401k plan select your mutual funds. That's another $15 billion a year in 12b-1 fees.  All in, we paid $650 billion for the fund industry to take us from 1998 to 2008 back to 1998 again.  

Unfortunately, there are more fees.  When your fund buys and sells stocks the commission is paid out of the fund assets.  It doesn't show up as part of your expenses, but you pay them.   Mutual funds pay about $70 billion in commissions every year.  For fairness, let's assume that only half of those trades are chasing after the wind.  That leaves you, this decade, with $350 billion in commissions paid to buy stock 'B' that ended up doing no better than stock 'A'.  

Total it all up.  Between 1998 and 2008 you paid $1 trillion in fees to do the impossible--make everyone a winner.  The only real winners are the fund managers who, on Thanksgiving, will eat a turkey paid for by turkeys.

If everyone just invested in a low-cost ETF vehicle like the Vanguard Total Stock Market Index (NYSEArca: VTI) the country would have paid about $50 billion over the past ten years. I'm not advocating Vanguard. It’s just an example. Putting everyone in Vanguard would create other problems. But we can't expect the fund industry or regulators to fight for lower fees for people who, if they really understood them, would not pay them.  

Other reasonably priced ETFs with broad diversification are the SPDR MSCI AWCI ex-US ETF (NYSEArca: CWI), iShares Lehman Aggregate Bond Index Fund (NYSEArca: AGG), and Vanguard REIT Index ETF (NYSEArca: VNQ).

The industry is creating low-fee funds.   But most people over the age of 30 are still in the old expensive variety.  Low-fee ETFs appeal to younger investors who aren't living in the past.  Even Fidelity has created low-fee index funds for the smart shopper.  Do you believe any young person would invest in Magellan (NasdaqGM: FMAGX)?

In the meantime, while you toss and turn in your sleep, you have a wake-up number. Hopefully the markets will come back and you'll soon have all the money you need and the fund industry can grow to be twice as fat, dumb and happy.  Or you may be looking at another wasted $1 trillion, courtesy of the turkey farm.

Max Rottersman is a partner of Hanover Technology Group, LLC. His opinions don’t necessarily represent the views of ETFguide.com or Yahoo Finance.