Vanguard Fund Costs Rise as Stocks Drop

Vanguard Group recently raised fees on some of its mutual funds. The expense ratio for the Intermediate-Term Tax Exempt Fund(VWITX Quote) climbed to 0.2% from 0.15%. It rose to 0.46% from 0.37% on the U.S. Value Fund(VUVLX Quote).

The news shocked some shareholders because Vanguard has always been viewed as a low-cost mutual fund manager. Has Vanguard changed its philosophy? Hardly.

The rising costs are a symptom of a weak stock market that has lowered Vanguard assets by $300 billion in the past year to $1.06 trillion. At the same time, the fixed costs of managing portfolios have stayed about the same. In rising markets, Vanguard passes on declining costs to shareholders. Now investors must shoulder a heavier load.

Vanguard isn't alone. In the past year, the expense ratio of the Fidelity Small Cap Stock Fund(FSLCX Quote) increased to 1.08% from 0.8%, while the ratio on the American Century Small Cap Value Fund(ASVIX Quote) rose to 1.49% from 1.26%.

The average expense ratio, or cost per dollar invested, for domestic equity funds was 1.03% in 2002, according to Morningstar(MORN Quote). As assets climbed, expense ratios dropped to 0.87% in 2007. That trend reversed last year, when the average ratio climbed to 0.88%. Morningstar predicts that expense ratios will rise further in 2009.

Should you sell a fund because it has become more expensive? Not if the fund is cheaper than most of its peers. But steer clear of funds with above-average expenses.

Funds with low expenses usually outperform high-cost funds. Recent research by Morningstar suggests they're also most likely to be merged out of existence or liquidated in bear markets.