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By Jason Stipp and Russel Kinnel | 09-11-2012 04:00 PM

Are Fund Investors Better Off Than Before?

Investors are broadly saving on fund fees versus 10 years ago, but there are still plenty of ways for them to lose money in risky or gimmicky vehicles, says Morningstar FundInvestor editor Russ Kinnel.

Jason Stipp: I'm Jason Stipp for Morningstar.

Are fund investors are getting a better deal than before? We're checking in today with longtime Morningstar FundInvestor editor Russ Kinnel on that question.

Russ will be sitting on a panel later this month, Sept. 19th. It's FundInvestor's 20th anniversary. He will be sharing some tips there, but we're going to get a preview from him today.

Thanks for joining me, Russ.

Russ Kinnel: Good to be here.

Stipp: A lot has changed in the fund industry; some things have stayed the same. I want to talk about whether fund investors are getting a better deal or a better experience out in the market today.

We've had, obviously, some issues in the last 10 years with market conditions, but as a fund investor, some things could be better for you.

Let's start with one of the, perhaps, most important ones: expense ratios--what you pay to invest in a mutual fund. Are fund investors getting a better deal today than they were 20 years ago or 10 years ago?

Kinnel: The answer is definitely yes. Expense ratios for the average open-end fund have come down significantly. The typical fund investor is paying just 77 basis points. So, they really have come down, and that's not even accounting for ETFs.

You bring ETFs into the picture, and it's even better right. The ETFs have really brought fees down. Not all of ETFs are cheap, but there are a lot of cheap ones. So, there are more cheap funds than probably ever before.

Stipp: I think investors often wrestle with the idea of getting what you pay for, which is something they experience in other parts of the marketplace.

But we've done a lot of studies on fees, and of course if you're getting active management, you want to make sure that active manager is doing well. But buying or paying extra for a mutual fund, especially an actively managed fund or any fund, doesn't always get you that outperformance, right?

Kinnel: That's right. Expenses are a strong predictor of fund performance. They're not the only thing you need to look at, but they are an important part of that.

I think one of the reasons people get confused is, some of the funds with low costs are actually in dollar terms taking in a lot of money, because maybe they're running $50 million, or in the case of PIMCO Total Return, $100 billion-plus. But people miss that and think about the expense ratio. But really in dollar terms, often the best managers are well paid. But yes, investors can get really good managers for low cost.

Stipp: And especially with something like an index fund, where it's essentially a commodity type of investment product, there is no reason that you should pay any more than the lowest price you can get, potentially?

Kinnel: That's right. And ETFs have really dialed up that competition. We've seen both on the open-end and the ETF side, firms have lowered their expenses in response to competition. So, definitely when you're looking for an index fund, cast a wide net and see how cheap you can find it.

Stipp: You mentioned ETFs there, Russ, and I think one thing ETFs have done is opened up certain areas of the market, for individual investors especially, that were difficult for them to invest in before.

So, my second question is about investors' choice, their selection in investment vehicles. How has that changed, and is more choice always a better thing for investors?

Kinnel: I think ETFs are great example that, on the one hand, they are a great place for a sober long-term investor. On the other hand, there are a great way for you to blow all your money really quickly, because you have some very obscure areas that ETFs mine. You can trade all day in them. So, you kind of have a casino on one end and a stately old bank on the other end attached to an ETF. So, there are some ways to get in trouble, or there are some ways to really invest wisely for your retirement.

Stipp: And some of those ETFs, and I know some of the newer alternatives, are using a lot more exotic instruments. To what extent is it difficult for investors to even understand these, and how can they get in trouble that way potentially?

Kinnel: I think it's true that you have to be a little skeptical about anything that's exotic or complicated, because that doesn't necessarily mean "better." It does mean higher fee, which again raises the bar and makes it harder for you to succeed.

So you really have to be careful, find a manager with an established track record, and a strategy you can understand. You don't have to understand all the intricacies, but you should have realistic expectations of the ups and downs of a fund, and if you can't do that, stay with something that's more plain-vanilla.

Stipp: What about the trend of fund companies putting out funds that are of the time--hot funds and hot asset classes. This is a trend we've been following for a while, and it can lead investors to put their money into something that's already reached or is close to reaching its peak.

Is this trend still continuing in the fund industry, or are fund companies getting a little bit more responsible about not putting gimmicky funds out there just to capture the next latest thing?

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