How Low Can Fund Fees Go?
Our research shows the average expense ratio for investors has fallen by more than half since 2000.
The average expense ratio paid by fund investors has been falling for over two decades. In 2020, the asset-weighted average expense ratio across all mutual funds and exchange-traded funds (not including money market funds and funds of funds) was 0.41%. This is less than half what investors paid in fund fees, on average, in 2000.
Fund investors themselves deserve much of the credit, as the shift toward low-cost funds has been the primary driver of this decline. While there is plenty to celebrate, investors mustn’t relent. Though fund costs have come down, the total costs borne by investors haven’t necessarily followed in lockstep. While some costs have diminished, others have taken new shape. For example, the cost of advice has increasingly been stripped out of funds’ fees and resurfaced in the form of advice fees. Investors should be ever vigilant of what Vanguard founder John Bogle referred to as “the tyranny of compounding costs” and keep accounts of what they’re paying for their investments, and advice.
Here's a closer look at some of the key takeaways from Morningstar’s latest annual fund fee study.
Asset-weighted fund fees fell to 0.41% in 2020 from 0.44% in 2019. While this might not sound like much, it amounted to $6.2 billion in savings for fund investors. And a few billion saved means more than a few billion earned in the years to come. Compounding investors’ 2020 fund fee savings at a rate of 0.71% (the 10-year expected return for a 60/40 stock/bond portfolio based on Morningstar Investment Management LLC’s forecasts of corporate and economic fundamentals) over the next 10 years would equate to just over $6.6 billion more in investors’ pockets come 2031.
These savings have disproportionately accrued to investors in passive funds. The asset-weighted fee across all passive funds has declined 66% since 1990, landing at 0.12% in 2020. Meanwhile, the asset-weighted fee paid by investors in active funds stood at 0.62% in 2020--a 33% decline over the same period. The chart below may be one of the few line graphs where investors will be pleased to see a slow and steady downward trend depicted.
Investors deserve most of the credit for putting the squeeze on fees. Asset-weighted fees have dropped more sharply than equal-weighted fees--meaning the average amount investors are paying for the funds they invest in has fallen more than the toll taken by the average fund. The fact that asset-weighted fees are persistently lower than equal-weighted fees indicates that investors, on average, choose funds with below-average fees.
The table below shows aggregate flows into all funds based on how their fees stack up versus their Morningstar Category peers. In nine of the last 10 years, the cheapest 20% of funds across all Morningstar Categories have, as a group, accounted for 100% of the net inflows into all funds. Meanwhile, money has poured out of the remaining 80% in all but one year over the past decade. The sums are staggering. More than $5 trillion has flowed into the low-cost cohort during this 10-year span, while almost $1.9 trillion has been pulled from the remaining funds.
The lion’s share of flows into low-cost funds has gone to index mutual funds and ETFs. These funds’ growth has been driven by a variety of factors: notably, shifting investor preferences, the evolving economics of the financial advice industry, and the ascendance of target-date funds as the default investment option in retirement plans.
Investors’ tastes can be fickle, but the trend toward indexing in general and ETFs in particular appears to be durable. Disillusioned with active managers and fed up with high fees and regular capital gains distributions, investors of all stripes have flocked to low-cost, tax-efficient index funds.
In the advice space, the shift away from transaction-driven business models and toward fee-based ones has led advisors to recommend lower-cost funds to their clients to, in part, make more room for their own fees, which are often charged as a percentage of client assets under management.
And in the retirement space, target-date funds have experienced significant growth as they are now the default investment option in many retirement plans. The majority of target-date fund assets are now in target-date series composed exclusively of index mutual funds. Taken together, these three factors help explain the sea change we have witnessed from active funds to passive ones, costly ones to inexpensive ones.
The table below shows the trend in equal-weighted fees for active and passive funds across Morningstar Broad Category Groups. From 2016 through 2020, the average expense ratio for passive funds dropped 12% and the average fee for active funds dropped 11%.
Fund companies are charging investors less than they were five years ago, partly because they are dropping certain line items from investors’ bills. As advice (for example, loads) and marketing and distribution costs (for example, 12b-1 fees) get scrapped to reflect the evolution of advisory practices, fund fees are getting stripped down to manufacturing costs (that is, management fees). This effect has been most pronounced among active funds, where these expenses are--or at least were historically--most prevalent.
The chart below shows the trend in asset-weighted fees for active and passive funds across Morningstar Broad Category Groups. From 2016 through 2020, the asset-weighted average expense ratio for passive funds dropped 25%, while the asset-weighted average fee for active funds dropped 16%. The rate of change in what investors pay, on average, for passive funds has been much greater than the rate at which these funds’ fees have fallen.
This reflects how acutely price-sensitive investors have become in this segment of the market. Broad-based market-cap-weighted index funds have become a commodity product. Differences in fees (if they even charge a fee) have become razor-thin; high-fidelity index tracking performance is table stakes. Market beta has become, for all intents and purposes, a public good.
Below you can see the summary fee data for the nine U.S. stock fund categories that compose the Morningstar Style Box. This provides further evidence that the trend in fees has been friendly to investors. Not only has the median U.S. stock fund gotten cheaper over the past 15 years, the most expensive ones have, too. The most encouraging figure is the one representing the level of the line that divides the cheapest 10% of funds from the rest. At 0.36%, this breakpoint was 41% lower in 2020 than it was in 2005.
The bar will go lower. The downward pressure on fund expenses is unlikely to abate. Competition has driven fees to zero in the case of a handful of index mutual funds and ETFs. The same forces that spawned these zero-fee funds have begun to spread to other corners of the fund market, areas where there is still ample room for fees to fall further.