How to Deal with High Index Fund Fees

Everyone knows a chief attraction of index funds is low fees. But some are lower than others, even on funds tracking the same index, such as the Standard & Poor’s 500.

A new survey by Morningstar Inc. (Stock Quote: MORN) finds annual fees on those funds ranging from 0.09%, for the Schwab S&P 500 indexer (Stock Quote: SWPPX) to a full 1% for the BB&T Equity Index fund (Stock Quote: BAEQX).

Fees, or expense ratios, are an annual percentage of the investor’s holdings, and even small fees can chew away at long-term results. Over the past five years, not a good period for stocks, the Schwab fund has lost an average of 0.22% a year, the BB&T fund has lost 0.9%. A $10,000 investment would have fallen to $9,890 in the Schwab fund, $9,559 in the BB&T fund, even though they are tracking the same stocks.

Why the big fee difference? And, more important, what should you do if you have an overpriced fund?

The reason, quite simply, is that most fund companies are out to make a buck and will charge as much as their customers are willing to pay. Index funds with high fees tend to be those sold by brokers and other financial advisers. In theory, the fees help pay for the advice. Indexers with low fees tend to be sold by fund companies that deal directly with investors and provide little or no advice.

But when it comes to index funds, especially those representing the broad market, how much advice do you really need? The whole idea of an index fund is to march in lockstep with the market, and to save the expense of analysts and stock pickers you have to pay for with an actively managed fund that tries to beat the market.

Also, index funds generally work best as long-term investments — for 10, 20 or 30 years. It doesn’t make sense to pay for advice year in and year out if you’re just sitting on the fund for the long term.

If the S&P 500 returned 8% a year, an investor putting in $500 a month for 30 years would end up with $696,892 in the Schwab fund, $588,000 in the BB&T fund. And this isn’t counting the damage done by BB&T’s other fee, a whopping 5.75% load, or sales commission, on share purchases. The Schwab fund, like many of the best indexers, has no load.

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