The Effect of Mutual Fund Fees on Performance: A Review of the Literature for Practitioners

Abstract

Like any consumer product, mutual funds are not free, and the associated expenses impact performance. Expense ratios and loads are negatively related to performance (Carhart, 1997; Dellva & Olson, 1998). As such, financial planners ought to educate their clients about the importance of minimizing fees. Although the impact on performance is mixed, 12b 1 fees are not found to reduce other expenses and should be avoided. Redemption fees and incentive fees can help align the interests of managers and other shareholders with those of long-term investment strategies. Any mutual fund with redemption fees can be beneficial, and incentive fees can be beneficial for actively managed funds, given that expense ratios are minimized. Because investors tend to pay more attention to loads and commissions, financial planners also have a responsibility to raise their clients’ awareness of high expense ratios and their effect on performance. An analysis of fees ought to be part of the due diligence performed by a financial planner. Because financial planners are frequently compensated on a fee-based structure, they may be hesitant to discuss the role that fees play on performance. However, Choi, Laibson, and Madrian (2008) suggest that clients will likely be grateful for the efforts to minimize expenses in order to increase expected risk-adjusted return. This effort to minimize expenses can also be highlighted when meeting with new clients in order to ease potential concerns about the additional cost of the financial planner.