$10 Trillion in Mutual Funds Go on Sale

In 1986, Merrill Lynch operated the biggest fund family. The list of top-20 fund sellers included such long-gone brokers as E.F. Hutton and Dean Witter. Those companies dispatched armies of brokers servicing clients who knew little about mutual funds. But by the 1990s, investors were savvier. They were learning about funds from companies such as Vanguard, which charged no loads.

To compete, broker-sold funds cut their loads or waived them altogether. From 1980 to 2008, the average front-end load paid by investors dropped from 5.5% to 1.1%, according to the Investment Company Institute, the mutual fund trade group. In 2008, investments with commissions of 4% or more accounted for only 8% of total sales recorded by adviser-sold funds, according to Strategic Insight, a fund research firm.

While loads dropped, many investors were also spending less on expense ratios. In 1990, the average dollar invested in domestic equity funds faced an expense ratio of 0.97%, according to Morningstar. By 2008, the figure had dropped to 0.88%.

Much of the decline in expense ratios can be traced to the fact that millions of investors became more educated about funds. After learning about fees and performance rankings, shareholders moved from high-cost funds to those with lower expense ratios. Today, the list of the biggest fund families is dominated by low-cost managers, including American Funds, Vanguard, Fidelity Investments and T. Rowe Price(TROW Quote).

In the competition to attract assets, low fees provide an important advantage. Because expense ratios are directly subtracted from returns, cheap funds tend to outperform expensive ones. So the performance standings are often dominated by low-cost funds. The winning funds attract more assets. As they grow bigger, the low-cost funds can lower their expense ratios even more because of economies of scale. This ensures that the cheap funds will stay at the top of the performance standings.