Investors Opt for Low-Fee Funds

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With the stock market roiling, it’s a good time to recommit to some investing basics, like the importance of hanging on through the downturns understanding fees.

When the market is down, the damage from fees goes from nibbling to chomping, doing even more to undermine performance. Fortunately, there is new evidence that investors really have become low-fee believers.

It comes from a new study by The Vanguard Group, the mutual fund giant that has made low fees the cornerstone of its investing strategy. Vanguard used market-wide data from Morningstar Inc. (Stock Quote: MORN) to see which funds investors had put the most money into in the 10 years ended Dec. 31.

In all categories, investors favored the quartile, or 25%, of funds charging the lowest fees.

Among stock funds, 86% of new cash flowed into funds charging fees no higher than 0.9% a year, the cheapest quartile. That category took in nearly $395 billion. The second quartile, with fees between 0.9% and 1.03%, took in the remaining 14%. The two quartiles with the highest fees, above 1.49% and 2.12%, respectively, actually experienced net withdrawals of $22.6 billion and $58.4 billion.

A further breakdown determined that 79% of the money that flowed into the lowest-cost quartile went into funds with rock-bottom fees of 0.1% or less, even though those funds make up only 7% of all stock funds.

The study found similar patterns with other types of funds. Among actively-managed stock funds, 55% of funds went into the cheapest quartile. The figures were 93% for indexed stock funds, 59% for exchange-traded funds containing stocks and 78% for bond funds.

The fee savings add up. Put $10,000 into a fund earning 8% a year and you’ll have $46,610 in 20 years, according to the Savings, Taxes & Inflation Calculator. If higher fees shave the return to 7%, you’d have just $38,697.

Why have investors behaved so, well, responsibly?

The growing availability of index funds and exchange-traded funds, most of which are indexed, is clearly one factor, Vanguard says.

In addition, about 80% of fund assets are held in accounts involving financial advisers or workplace retirement plans. Workplace plans like 401(k)s have added more index funds to their offerings, and advisers have been moving from commission-based, transaction-oriented payments to a fee-based system, which is more likely to encourage a low-cost, buy-and-hold investing strategy.

Moreover, the smaller returns of the past decade, which had two market crashes, have drawn attention to the benefits of low fees, which have been the focus of much coverage by the financial media, Vanguard says. Finally, the Internet has made it easier for investors to get fee information.

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