Ignore Fee Data at Your Own Expense

Question: Under the Expense tab on the Morningstar.com fund pages, I see a Morningstar Category Average number and a Fee Level Comparison Group Median number. What do these mean, and how are they different? 

Answer: The statistics you mention are measures of how a fund's expense ratio compares with those of its peers, but the peer groups are slightly different. The Morningstar Category Average simply looks at the average expense ratio across all funds in the same category, just as it sounds. 

The Fee Level Comparison Group Median is slightly different. First, it's a median rather than an average. It also groups funds differently based in part on distribution channel and expense structure.

To understand this, consider that a no-load, domestic small-cap value fund's category average expense ratio would simply be the average of expense ratios for all domestic small-cap value funds. However, in addition to no-load funds this average includes funds that charge a sales load, which often cost more than no-load funds, as well as institutional share classes, which typically cost less than share classes available to retail investors. To address these key differences and offer more of an apples-to-apples comparison, the fund's expense ratio also is compared with a Fee Level Comparison Group with similar expense characteristics. So a small-cap value fund that charges a front-end load is compared with the small-cap front-load Fee Level Comparison Group while a small-cap value fund's institutional share class is compared with the small-cap institutional group. How the fund compares with others in its Fee Level Comparison Group determines its Fee Level rating. The cheapest 20% of funds in each group carry a Fee Level rating of Low, with those falling into each subsequent 20% rated as Below Average, Average, Above Average, or High. You can read more about how the Morningstar Fee Level is compiled in this methodology document. 

Digging Deeper Into Fees
Farther down the page on Morningstar.com, you'll find additional fund-expense information, including any sales fees (loads) associated with the fund and the projected total cost per $10,000 invested of owning the fund during three, five, and 10 years. When researching any fund, it is important to understand whether these sales fees apply as this represents an additional one-time charge on top of the annual expense ratio. A fund with a Low expense ratio rating but that charges a sales load may not be such a bargain after all, especially if you don't plan to own it for long or if you don't need the help of an advisor.

At the bottom of the Morningstar.com page is a breakdown of various fees and expenses associated with the fund. You'll see a net expense ratio from the fund's annual report and another from its most recent prospectus, which may be more up-to-date. However, the fee comparisons at the top of the page and on the fund's Quote page are based on the annual report information only. That's because an expense ratio from a fund's annual report is audited and based on what was actually charged during the previous year whereas the expense ratio from the prospectus represents an estimate for what will be charged in the year to come. Below these are actual and maximum management fees as listed in the fund's prospectus. You'll also find a line for the fund's 12b-1 fee, if any, which represents a fee used to cover its distribution costs. Management, administrative, and 12b-1 fees all are components of the fund's net expense ratio.

Last of all, you'll see whether the fund currently has any fee waivers in place that may temporarily lower the fund-ownership cost to shareholders.

The Bottom Line on the Bottom Line
The higher the fees mentioned above, the less of the fund's return is passed on to shareholders. So a fund that gains 10% (including dividends) in a given year but that charges 1% in fees will return 9% to its shareholders, while another that performs exactly the same but charges just 0.1% will return 9.9%. As you can see, minimizing fees and expenses is an important part of being a successful investor, especially during long time periods when the effect of high fees is compounded and acts as a drag on performance. That's why any investor would be well advised to pay close attention to the information provided within the Expense tab.

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