Tired of Just Losing Money, Funds Will Charge More in '03

Mutual fund companies have spent the last three years losing your money.

Now, they could end up charging you more.

Higher fees are just one of the treats that fund investors can look forward to in the new year.

Facing business pressures from a sour market, fund companies have spent the past year trying to cut costs, stay profitable and still sell funds. And this bear-market austerity could mean higher fees, more load funds, additional fund mergers and closures, and few new funds in 2003.

Sadly, these trends are not your friends.

Fee Hike

Broadly speaking, the less money in a mutual fund, the higher the fees. And with assets dwindling in stock funds this year thanks to redemptions and market losses, expenses could creep higher.

The average U.S. stock fund has fallen another 21% in 2002. And through the end of October, investors had pulled $26.5 billion in cash from stock funds.

Dwindling assets can force a fund's expense ratio higher in a couple of ways. First, remaining shareholders bear a greater share of the costs of operating the fund, which would include fees for regulatory filings and legal and accounting work. Then the management fee, which is the other main component of a fund's expense ratio, could also move up. Some funds have thresholds in the management fees they charge, where those expenses inch higher as assets decline.

Now, if you're invested in a multibillion-dollar fund, you probably won't see a big uptick in expenses. But shareholders in funds with $100 million or less, where fixed costs start taking a nice chunk of assets, could see a noticeable difference.

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Some funds also cap their total expense ratios to make fund expenses and returns look more attractive. And you could see some of those perks fall by the wayside if times continue to be tough.

You should also be on the lookout for extra fees that a fund company might tack on for low account balances. Twenty-four bucks a year might not sound like a lot of money, but on a $1,000 account, that's an extra 2.4% a year. And in a market that might return only 5% next year, that's half of your return flying out the window.

Loaded Up With Loads

The number of load funds continues to increase every year. And 2003 shouldn't be any different.

In this rotten market environment, more and more fund companies are relying on brokers and financial advisers to sell their products. Those folks have to be compensated somehow. And sales charges, or loads, do just that. In the past year, Invesco tacked loads onto its funds. Columbia did the same in November.

So if you're trying to invest on your own, you'll probably have even fewer no-load options to choose from as the new year progresses.

Offer What You Can Sell

Fund companies are only going to offer and run portfolios that they can sell. To that end, you should see more dreadful funds being closed or merged out of existence in 2003, plus a smaller number of new funds hitting the market. And of the funds that do get launched next year, they'll probably be super-safe funds that are an easy sell.

In 2001, 865 distinct mutual funds were merged or liquidated out of existence, according to data from Morningstar. Through December, the count is a much smaller 306 for 2002. However, that trend should still continue into 2003.

Fund companies are still trying to figure out what to do with the portfolios that have been failures.

A typical scenario: A fund's assets shrink dramatically, thanks to a combination of market losses and redemptions. And with a bad performance and an unappealing investment objective, such as only investing in technology, a fund's assets probably won't grow in the future. The shrinking portfolio becomes more expensive to operate; better to put the fund out of its misery.

A fund merger is also a way for a money management firm to reduce redundancy and improve the appearance of its overall performance. The record of a fund that's been merged into another disappears. For prospective investors, a company's fund roster will look a lot better without that struggling growth fund in its lineup.

Janus recently announced that it's merging the ( JTWOX) Janus 2 fund into its older ( JANSX) Janus fund and the ( JASSX) Special Situations fund into ( JSVAX) Strategic Value. These changes will take place in late February. Again, the trend continues.

Fund companies do have another option: simply close a fund. But often firms would rather hang onto those assets than give shareholders their money back. However, liquidations do happen: General Electric's ( GE) money-management unit is closing down five of its 35 funds. In fact, total fund liquidations are outpacing mergers this year.

So funds should continue to disappear. And the new portfolios that fund companies do cook up will be ones they can easily market and sell.

After three down years in the market, you can expect to see safer funds, such as the principal protected funds that have been hitting the market this year. Pioneer just launched one of these funds, which owns a collection of stocks, bonds and cash wrapped up in an insurance contract that, you guessed it, protects your principal.

In theory: They sound great. In practice: These funds can be incredibly expensive. And that gets back to the most important trend to watch for: higher fees.

In a lackluster market, lowering the cost of investing becomes even more crucial.

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