Watch Out for Rising Costs

Mutual fund expense ratios were flat to slightly lower in 2008, but you're likely paying more than that now. (To see all the data on asset class trends click here.)

Looking at asset-weighted retail expense ratios from 2008, most asset classes saw a 1 basis-point drop or no change from 2007. Overall, the asset-weighted average annual expense ratio dipped from 0.88% to 0.87%, though U.S. equity funds rose a basis point. Bond-fund expenses dipped as did those of international-equity funds.

Unfortunately that trend has likely reversed, and many funds today are charging more. The reason is easy to see: Mutual fund assets (excluding money funds) totaled $5.9 trillion at the end of February 2009, down sharply from $8 billion at the beginning of 2008.

In fact, Vanguard announced that expense ratios are rising at a bunch of its funds. The same is true elsewhere, but other fund companies are not calling attention to it.

It's not that fund companies or their boards are moving to raise fees. It's that mutual fund management fees have set breakpoints that trigger cuts or hikes as assets in the fund rise or fall. For example, a management fee at a fund might be 70 basis points for the first $1 billion, 65 basis points for $1 billion to $5 billion, and 60 basis points for all sums above that. Thus, shifts in assets automatically trigger cuts or hikes in fees.

The 2008 annual expense ratios understate the hike because they reflect what fundholders paid over the course of last year. Because assets today are down 30% to 60% from January 2008 at the typical equity fund, the 2008 expense ratio figures don't include the full effect of a fund's current fee structure.

To get a sense of where the figures are headed, I looked at prospectus net expense ratios. The prospectus net expense ratio reflects the fund's current fee level as of the time the prospectus is printed and can be a more timely measure of what to expect. However, you can't make this comparison with funds of funds because the annual report doesn't include underlying fund expense ratios but the prospectus expense ratio does.

The prospectus net expense ratios signal a reversal in the trend toward lower fees. Domestic equity funds' weighted average could rise by 2 basis points. International could pop up by 4 basis points. Taxable bonds should be the same, but munis could pop 4 basis points.