As Index Funds Become Even More Popular, Fees Are Plunging

NEW YORK (TheStreet) -- Getting something for nothing may be an oxymoron on Wall Street, but fees on index mutual funds are closing in on zero.

Fees on stock index mutual funds plunged 56% from 2000 to 2013, to an average 0.12% from 0.27%, according to an Investment Company Institute study.

And the decline isn't over. Some funds, including those from Vanguard and Fidelity, now charge less than half last year’s average.

Actively managed funds -- where fund managers pick stocks rather than just mirror stock indexes -- are also lowering fees, though not nearly as much. Managed stock fund fees dropped 16%, to 0.89% from 1.06%, during the same 13-year period, while managed bond fund fees fell to 0.65% from 0.78%.

Actively managed funds now are seven times more expensive than index funds, compared with four times as expensive back in 2000.

There’s nothing mysterious about the heavy discounting of index fund fees. Investors are pouring money into index funds faster than they are into actively managed funds, so index funds can afford to charge less and still increase profits. In business parlance, it's known as economies of scale.

As an added bonus to investors, index funds have been outperforming many managed funds. For instance, the largest stock index fund, Vanguard’s Total Stock Market Index (VBTLX) , is up 9.4% this year and charges only 0.05% on an investment of $10,000. By comparison, a big managed fund like American Fund's Growth Fund of America (AGTHX) charges 1.46%, but is up only 7.6% for the year.

Another factor enabling index funds to cut costs to the bone is that their energies are largely devoted to a single commodity-like product -- large cap domestic stocks -– that are cheaper to manage than the increasingly more complex mix of shares held by the actively managed funds.

How low can the index expense ratio fees go? If more people continue to invest in index funds, the fees are likely to move even closer to zero.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


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