Don't let expenses eat fund holdings

You see a pair of pants at one store for $75. They're $50 atanother. Which do you buy?

Most people look carefully at the price tag on a pair of pants.But when it comes to mutual funds, they ignore the price.

The price tag on a mutual fund includes not only the load, orsales charge. Just as important are a fund's expenses - what itcharges shareholders each year to run the fund. Of course, lowexpenses don't necessarily mean a fund is a good buy. But a fundthat keeps a close watch on its expenses has a better chance of doingwell.

The easiest way to compare expenses is to look at a fund'sexpense ratio. That shows the percentage of assets that managementtakes each year to pay expenses. Funds must show the expense ratioin their prospectus, the legal document you get when you firstinvest.

The expense ratio includes rent, salaries and 12b-1 fees, whichpay certain marketing expenses. It doesn't include salescommissions, or loads, that you pay a broker or financial planner.

The average expense ratio for diversified U.S. stock funds is1.42 percent of assets, says Lipper Analytical Services.

Why worry about expenses? Performance: Funds with high expense ratios tend to be long-termlaggards. The average stock fund has risen 230 percent over the last10 years.

In contrast, funds with above-average expense ratios have risen190 percent on average; funds with below-average expense ratios areup 242 percent.

Expenses are vital to bond funds, too. The average U.S.government securities fund has a 1.22 percent expense ratio. Thelast 10 years, the average government bond fund has risen 98 percent.

Funds with above-average expenses have risen 89 percent onaverage, compared with 103 percent for funds with below-averageexpenses. Principle: Funds argue - rightly - that services to shareholdershave increased dramatically. If you want 24-hour customer service,someone has to pay the salaries of the people who answer the phonesat 3 a.m.

On the other hand, "Our service costs have come down as our sizehas increased," says John Brennan, president of Vanguard, thenation's second-largest mutual fund company.

Vanguard has a rock-bottom 0.35 percent average expense ratiofor its general stock funds.

So why are fees rising? A large percentage of expenses gotoward marketing a fund.

Mutual funds argued heavily for 12b-1 marketing fees, sayingattracting more shareholders would mean larger funds and lower costs.

Funds got larger, all right, but expense ratios at many fundsdidn't go down.

Where does all the extra money go? Straight to fund companies'profit margins, which can average 20 percent to 30 percent aftertaxes - some of the highest of any industry.

If your fund company raises fees, write a warm note to the boardof directors.

And if that's not pointed enough, you can use your proxy powerto vote against fee increases. That may not stop the increases, butit will deliver a message.

From time to time, I hear about whoppers unscrupulous brokerstell customers to sell shares. The most recent whopper: Load fundsare cheaper in the long run. The argument goes like this: No-loadfunds have higher expense ratios than load funds. So even countingthe sales charge, a load fund is a better deal in the long run.

"Basically, it's not true," says Amy Arnott, editor ofMorningstar Mutual Funds, which tracks fund performance.

Of the 15 fund groups with the most stock-fund assets, the groupwith the lowest expenses for its diversified U.S. stock funds isVanguard, a no-load group. Fidelity, T. Rowe Price and TwentiethCentury, no-load groups completely or partially, have below-averageexpenses.

Putnam and Merrill Lynch - load groups - have some of thehighest average expenses on their U.S. stock funds.

You can, however, get top-notch performance and below-averageexpenses from both load and no-load funds. Just shop carefully.