Lets face it…most actively traded mutual funds are pretty much the same. There is a herd mentality. It does not pay for a mutual fund manager or the mutual fund’s parent company to stray too far from its predetermined investing style and the major index that it follows. Most large capitalization (Large Cap) mutual funds invest in the same small set of companies. Most of these companies are listed in the big indexes like the Standard and Poor’s 500 (S&P 500), etc. It is much easier to match or come close to beating an index if you and your mutual fund are quasi-indexes of it in their own right. It is safe to go with the herd in this case, and that is why so many mutual funds do it and look a lot alike.
But, there is one great indicator of mutual fund success that most people forget about. Many investors are wrapped around the axle about past performance, and they do not pay enough attention to a mutual fund’s expenses. Burton Malkiel and Charles Ellis make a great argument to buy share in mutual funds with low expenses in their new book, “The Elements of Investing“. Because many mutual funds are a lot like, you can increase the profit in your pocket by picking funds that minimize their expenses, fees, and turnover rates. A 401-k plan with a 1.5% annual expense rate can expect to earn 20% less over the course of an investing lifetime than a mutual fund with an expense ratio of just 0.5%.
The book’s authors found that there is a direct correlation between low fees and a mutual fund’s performance over a long time horizon. In their study, the fees charged and the fund’s turnover rates dragged down the rates of returns of the average mutual fund over a 15 year span. The higher the fees you pay on average, the lower your rate of return. When mutual funds look more and more alike and start to resemble more of the index they follow, a fund’s costs may be one of the deciding factors that will help you get over the top with your investing dollar.