Can't Control the Markets? Try controlling the Costs

Submitted By Tushar Mathur

You can't control the markets, but you can control investing costs

As 2008 proved, the financial markets are prone to unpredictable periods of turbulence. That can make investing feel a bit like a roller-coaster ride. The disappointing results that many mutual funds posted in 2008 and at the outset of 2009 may have left you feeling concerned over your financial future. You're not alone.

However, one maxim seems to hold true: There's one very important element affecting long-term investment return that you can exert a great deal of control over, and that's your investing costs.

Keeping costs to a minimum can help boost long-term investment success. That's because every dollar paid for management fees, trading costs, and taxes is a dollar less of potential net return. And while some costs are not as transparent to the average mutual fund investor, a fund's expense ratio is always transparent.

Although lower costs aren't a guarantee of superior mutual fund performance, higher costs don't necessarily translate into higher returns either—turning the adage "you get what you pay for" on its head.

The track record: Higher costs have often led to lower returns

In the interactive illustration below, U.S. stock funds are divided into three categories: small-capitalization, mid-cap, and large-cap, reflecting the size of the companies the funds invest in. The funds are further divided into quartiles (that is, 25% of each respective group), based on expense ratios. As you can see, the best-performing funds for the period were the ones with the lowest costs in almost all capitalization and expense categories.

The components of investment cost

The costs associated with investing in a mutual fund include operating costs—the fees paid to the fund's portfolio manager—as well as recordkeeping, administrative, and reporting expenses. Together, these costs are deducted from every fund's earnings and are expressed as its expense ratio.

Other costs can also affect your mutual fund returns. For example, some funds charge a 12b-1 fee, which covers the marketing and distribution costs. Sales charges may apply if you choose to invest in a fund that collects a front-end load. Yet another expense is the cost of trading securities, including brokerage commissions.

When thinking about the impact of costs on your own investments, bear in mind that although the cost factors that make up a fund's expense ratio aren't directly deducted from your accounts, they do act as a drag on your net returns.