If you are using Vanguard mutual funds or ETFs to build your investment portfolio, may it be a retirement account or regular brokerage account, you are going to like this piece of news.

Vanguard announced on December 28th that starting December of 2012, the company changed expense ratios (ERs) of a number of funds (so it has already been in effective). In total, 37 mutual funds and 26 exchange-traded funds (ETFs) were affected by the latest adjustments and most of them have their costs reduced between 0.01% and 0.05%, but not all of them. The exceptions are 2 ETFs and 7 mutual funds:

• S&P Small-Cap 600 (VIOO): ER from 0.16% to 0.17%
• S&P Small-Cap 600 Value (VIOV): ER from 0.22% to 0.24%
• Explorer Value Investor (VEVFX): ER from 0.61% to 0.63%
• International Growth Investor (VWIGX): ER from 0.47% to 0.49%
• International Growth Admiral (VWILX): ER from 0.34% to 0.36%
• S&P Smal-lCap 600 Index Institutional (VSMSX): ER from 0.09% to 0.10%
• S&P Small-Cap 600 Value Index Institutional (VSMVX): ER from 0.10% to 0.12%
• U.S. Growth Investor (VWUSX): ER from 0.44% to 0.45%
• U.S. Growth Admiral (VWUAX): ER from 0.30% to 0.31%

You can find the complete list of ETFs and mutual funds with their new ERs on Vanguard website.

What I noticed from the announced fee cut is that most funds in the list are actually sector funds and none of the Vanguard funds, ETFs or mutual funds, I am using in our retirement accounts was included, so the changes didn’t really affect us. The funds we currently hold in a number of IRA accounts are:

• MSCI Emerging Markets ETF (VWO): ER 0.20%
• Small-Cap Value ETF (VBR): ER 0.21%
• Total Stock Market ETF (VTI): ER 0.06%
• REIT ETF (VNQ): ER 0.10%
• Wellington (VWELX): ER 0.27%
• Total Stock Market Admiral (VTSAX): ER 0.06%
• Total International Stock Index Admiral (VTIAX): ER 0.18%
• 500 Index Fund Admiral (VFIAX): ER 0.05%
• Emerging Markets Stock Index Admiral (VEMAX): ER 0.20%
• Inflation-Protected Security Investor (VIPSX): ER 0.20%
• Small-Cap Value Index Investor (VISVX): ER 0.35%
• Intermediate-Term Bond Index Investor (VBIIX): ER 0.22%
• Total Bond Market Index Investor (VBMFX): ER 0.22%

For our investments, we have gradually shifted to Admiral shares to further reduce costs after such an option became available a few years ago, except those that either are not yet eligible or have no Admiral shares available. The current threshold for converting from Investor shares to Admiral shares is $10,000. If you have Vanguard funds with more than $10,000 in market value, but haven’t converted them into Admiral shares yet, it may be a good idea to do the conversion now to save your overall investment costs over the long term.

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Are you concerned about investment costs, such as commissions, mutual fund fees, and any additional administrative fees?

The costs to invest are always the No. 1 concern to me. That’s why I always look for stock brokers with the lowest commissions to trade stocks and mutual funds with less 1% fees to invest for the long-term (usually index funds have much lower fees than actively managed funds do), in both regular investment accounts and retirement savings accounts. Since there’s no way to totally avoid these costs, despite that mutual funds are getting cheaper to invest recently, the best I can do is to reduce the fees to the minimum so that the fees won’t eat a big chunk of my investments. This is especially true for retirement accounts.

However, the problem for retirement accounts is that since I use mutual funds in my 401(K) and IRA accounts, the cost isn’t that as obvious as the commission fee that I was charged every time I trade a stock. Plus, I usually own multiple funds in my accounts and even though I know how much administrative fee each individual fund charges, the overall cost of the entire portfolio isn’t that clear. So I think it would be nice if there’s a tool to calculate the cost based on the funds I own and the value of each fund. Everybody knows that the less the fees, the more I got to keep for myself. The question is how to figure out exactly what I am paying right now across different accounts.

I recently took a look at Personal Capital’s 401(K) Fee Analyer in hoping that it can answer my question. It is a free tool from Personal Capital, but in order to use the tool, you need to register with your email address and phone number and create a password. It’s a very simple process and doesn’t cost anything. Once an account is created, you will then need to link your 401(K) account to Personal Capital so that it can analyze it. According to Personal Capital, the costs of a 401(K) plan is calculated based on:

• The the expense ratios of the funds in your 401(K), which you can find in the fund’s prospectus.
• The plan’s administrative and advice fees. You should be able to find these fees in your plan statement as providers are recently required to disclose a fund’s administrative and advice fees.
• Unpublished fund fee data, which you should be able to find in the plan statment as required, even though this information is not publicly available.

Since I am very eager to know my investment costs, I registered with Personal Capital and linked my 401(K) account at Fidelity. However, after playing it a little bit, I left disappointed because I didn’t get what I was looking for. The reason I am guessing is that funds currently held in my 401(K) account are particularly offered by my employer, so they don’t have the ticker symbols that normal funds do. And because of this, Personal Capital is not able to analyze that funds and figure out the Expense Ratio (ER) and the annual cost of owning those funds. Instead of telling me the true costs of my 401(K) plan, what I got was an estimated total costs over the years based on different ratios of Plan Administrative Fees (the second item in the above list that doesn’t include ERs), as you can see from the screenshot above. Since my two 401(K) accounts, and my wife’s account, are all made up with funds that don’t have standard symbols, I wasn’t able to find out the costs of my plans My employer used to offer Fidelity funds in the 401(K) plan, but later shifted to only custom-made funds.

I am pretty sure there are plenty of people who can only invest in funds custom-made for them by their employers and it is a pitty if we couldn’t find out such important information as the total costs of our investments. Actually, if you look at the above screenshot, all it needs to calculate the costs are ERs plus administrative fees of the funds. Even though the funds in my 401(K) plan don’t have valid symbols, they do have the data availble for me to view. If Personal Capital allows me to manually enter the data into their Analyzer, then I will be all set and this tool will be more useful. This could be a simple solution for the problem.

Of course, once you created a Personal Capital account, you can do more than just analyzing your 401(K) costs. In fact, it also lets you link regular investment accounts or even bank accounts so that you can view them all together. However, this function is not new. There are quite a few other tools can do that for you as well. For example, you can manage all your bank and credit card accounts using Mint and using Wikinvest I can track all my investments. But none of them analyze investment costs for me, so Personal Capital is quite unique.

Are you using the 401(K) Fee Analyer from Personal Capital? If so, are you able to find out the overall costs of your plan?

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Recently, I wrote about that in general mutual fund management fees have been falling in the past two decades. The management fee, in terms of expense ratio (ER), is the fee that mutual fund companies charge their customers for owning the fund. This is significant because, as I mentioned in the article, management fees are paid by investors directly, therefore, the less the fees being charged, the more the money being invested. Examining closely a fund’s ER is an important step during the research phase before deciding on which funds to invest.

In addition to the management fee, some mutual funds also charge another fee called early redemption fee. It is the fee that you will have to pay if you sell your mutual fund shares within, say, 60 or 90 days after acquiring them. As you can see, this fee, usually a percentage of the value of shares redeemed, is different from the management fee because it only occurs if you redeem your shares within the set time period, while the management fee follows you as long as you own shares of the fund. Unlike stocks, mutual funds are supposed to be long term investments, something that should not be bought and sold very frequently (well, exchange-traded funds (ETFs), a variation of mutual funds, make trading mutual funds like stocks possible). By charging customers early redemption fees, mutual fund companies try to discourage their customers from making quick turnovers of mutual fund shares in order to protect long term investors. Despite the difference between the early redemption fee and the ER, which can’t be avoided, it is still a fee that could cost investors. So it would be nice to see it gone.

If that’s your hope, then Vanguard has just answered it by announcing that it has gotten rid of the early redemption fees of 33 of its mutual funds. Currently, Vanguard charges 2% on shared sold within two months of purchase on some of its index funds and actively managed funds, for both Investor Shares and Admiral Shares if offered (see complete list of funds that no longer charge early redemption fees). While announcing the elimination of early redemption fees, Vanguard also said that they still have “other measures in place to protect the interests of long-term investors and to discourage frequent trading,” including imposing a mandatory 60-day waiting period after a transaction, buy, sell, or exchange, was made.

For me, I have barely paid any attention to the early redemption fee because I haven’t sold any mutual fund shares in years. A few rare occasions when I encountered such an issue were when I tried to exchange one fund that I dollar-cost averaged every month to another one. In those cases, I just had to stop the automatic DCA and wait for two more months before I eventually performed the exchange. So it’s never really a problem for me, just like I was never bothered by late fees or high interest rate charged by credit card companies.

I don’t know how much early redemption fees Vanguard has collected from its customers. Given the number of people investing with Vanguard, I will just assume it’s not a small amount. So it’s probably a nice revenue to lose.  However, as an investor I am not too excited by the announcement because, if Vanguard already has measures in place to prevent frequent trades of its mutual fund shares, then the early redemption fees are not really necessary and when you get rid of something that’s not necessary, it only makes a good gesture. I would rather see Vanguard further lower ERs of their funds to benefit every investor in the long term, though they probably already have the lowest ERs in the industry

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In terms of expense ratio.

When it comes to selecting what mutual funds to buy, one of the important factors to consider is how much they will cost you to own the funds. When buying stocks, I would generally want to go with the broker that charges less commission for each trade. The reason is pretty simple. If I have $100 to invest, the less commission I pay, the more I can actually use to buy shares. The same is also true for mutual funds, even though it’s not that obvious on the surface. For example, if I have $100 and want to use that money to buy, say, Vanguard S&P 500 Index Fund (VFINX) from Vanguard. At today’s closing price of $126.07, the $100 I have buys me 0.787 ($100/$126.07 = 0.787) shares. It doesn’t seem to cost me anything at the time when I purchased the  share, but I will still pay for my investments.

For mutual fund investment, since every fund is different, there are usually more to take into consideration when making selections, including performance, asset allocation, risk, manager tenure, and, of course, costs. Mutual fund fees are more subtle than the trading commission for buying stocks because you don’t usually pay the fees upfront as you would do when trading stocks, unless it’s a fund with a front load. Rather, mutual fund fee, appearing as expense ratio (ER) in a mutual fund’s prospectus, is an operating expense that is used to cover the cost to operate the fund, just like the cost to operate any other business. For actively managed funds, a large portion of the fund’s total cost is paid to fund managers to research on what stocks to be included in the fund’s portfolio. The expense ratio is calculated on a yearly basis against the total assets under the fund and given a percentage value. Unlike the costs in trading stocks, which occur at the time of a transaction, such as buying and selling shares, mutual fund operating expense, also call management fee, is ongoing as long as you own the fund and they are taken out directly from the fund’s assets every year.  What it means to fund investors is that it will reduce the return of the fund because the return is calculated after subtracting operating expense from the fund’s total asset value. Since the fund’s asset comes from contributions from every fund investor, if you are investing in a mutual fund, then you are paying for the management fee.

While you can’t avoid paying the fee when investing in mutual funds, the good news is that over the long term, mutual funds are getting cheaper as the expense ratios are coming down steadily. According to a Morningstar article yesterday, the average expense ratio an investor paid in 2011 was 0.75%. That’s nearly 20 basis points lower than the average ER 20 years ago. As explained above, a lower fee means a better return for investors. Even though mutual fund companies have cut fees over the years, it is us investors and the decisions we made on where to put our money that had “the greatest impact” on the mutual fund fees as more and more opted to buy funds with lower costs then their peers.

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One of the earliest articles I wrote about investing in mutual funds was how to understand Morningstar Star Rating system and use it to research mutual funds.  It has been a while since that article was written and I haven’t added any new fund to my taxable investment accounts for years, so I haven’t used it for quite some time as you can see. However, I still consider the Star Rating a valuable tool when evaluating funds because it gives me a quick idea of how a fund has performed, in the past of course, which also makes the Star Rating kind of backward-looking. Even though we all know that, for mutual funds, past performance doesn’t guarantee future return, a good tracking record is still meaningful to some extent.

While the Star Rating is  helpful in the mutual fund research process, its heavy reliance a fund’s past performance also presents a problem for potential investor. When we buy a mutual fund, what we care about is how it will perform in our portfolio going forward, not really its history. But a fund that is rated five stars will no doubt gives one the impression that it’s superior than funds that have only four star rating, especially if he or she doesn’t know what exactly the star rating means and how it is derived by fund analysts. For anybody who’s new to mutual fund investing, the Morningstar Star Rating system could be confusing and even misleading.

So to correct this “problem”, Morningstar has recently launched a new Analyst Rating system to help mutual fund investors understand better a fund’s past performance as well as future prospect. The Star Rating itself is the same as it was before. What has been added to the overall rating of a fund is an all new Awards system that designates a fund as Gold, Silver, Bronze, Neutral, or Negative based on Morningstar fund analysts’ opinion on the fund’s future. The Gold, Silver, and Bronze present a positive forward-looking view of the fund, while Neutral or Negative means the fund is unlikely to stand out from its peers.

The new rating system not only looks into the fund’s the past performance, as the Star Rating does, but also examines how much the fund charges investors for owning the fund, the managers who run the fund, the company that owns the fund, and how the the investments in the fund are selected. According to Morningstar, the analyst rating is

a forward-looking, comprehensive and qualitative look at a fund’s competitive advantages or lack thereof. The new scale runs from Gold, Silver, and Bronze on the positive end to Neutral and Negative. Expressed as medals, the top three tiers are reserved for funds our analyst team thinks have sustainable advantages that position them well versus peers and a relevant benchmark on a risk-adjusted basis over the long haul (at least the next five years).

As you can see from the above screenshot, the new medal is prominently displayed alongside the Star Rating on Morningstar’s fund page. Now with the Star Rating representing the past and the Analyst Rating indicating the future, probably you can have a better idea of a fund when you go to Morningstar for your mutual fund research

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