Cutting Your Portfolio's Costs

The odds are good that whatever you're paying for your mutual funds and other investments, it's probably higher than it needs to be. Cutting costs is one of the few surefire wins in investing: Every dollar that doesn't disappear to expenses is another dollar that stays in your portfolio, benefiting from compounding over time. And the sooner you reduce costs, the more time you give your money to compound.

Let's say you have $300,000 invested in various mutual funds. Assuming those funds have an expense ratio of 1.28% (the average for large-cap blend funds in Morningstar's database), you're paying about $3,840 in expenses each year--and that's not including brokerage fees, transaction costs, or taxes.

What if you cut those expenses in half? How much better off would you be in retirement?

Let's say your original, expensive portfolio appreciates 8% per year for the next 15 years. By year 15, you'll have accumulated $795,808. But if you cut your fund expenses in half starting now, you'd add about 0.64% to your annual return. It doesn't sound like much, but thanks to compounding, these savings result in a portfolio worth $870,480 in 15 years. So your total savings would be worth more than $70,000 under these assumptions. Compound interest truly is the eighth wonder of the world.

Action Plan
In the following action plan, we'll show you how to start capturing
those savings so your portfolio can benefit.  

1) First, find out how much you're currently paying in fund expenses. Go to Morningstar.com's Instant X-Ray tool. You can also find this tool listed within the Tools tab of Morningstar.com.

If you haven't saved your portfolio on Morningstar.com already, you can easily do so within the Instant X-Ray tool. That way, you can always perform this kind of detailed analysis without having to re-enter your holdings every time.

2) Once you've entered your holdings and weightings in Instant X-Ray, hit the "Show Instant X-Ray" button at the bottom of the screen. You'll then see a section called "Fees & Expenses," where you'll find several key numbers, including:

a) Your portfolio's average expense ratio. We weight this ratio by the amount of assets in each fund, so it's the true overall expense ratio of your fund portfolio.

b) The average expense ratio of a benchmark portfolio. If your expense ratio is higher than this figure, you're paying more than the average investor. Even if it's lower, chances are there are funds in your portfolio for which lower-cost alternatives exist.

c) The total annual expenses in dollars. This is a good estimate of what you can expect to pay in a typical year. 

d) Still within Instant X-Ray, find your top holdings, which are listed at the bottom of the screen. To find out the expense ratio for each of your funds, click on each fund name to see its Fund Report. There, under "Fees & Expenses," you'll see the fund's expense ratio. Find the funds that are contributing the most to your portfolio's overall expenses. They're prime candidates for replacing.

3) Once you've determined how costly your portfolio and its constituents are, you're ready to address the problem areas. With more than 15,000 mutual funds to choose from, there's no excuse to be stuck in a bad one. (Unless, of course, you're locked into a retirement plan, such as a 401(k), that contains poor funds.)

4) To search for cheap funds, use Morningstar.com's Fund Screener.

Here, you can set your own threshold for expense ratios: either less than the category average, or less than 1.0%, 0.5%, etc. For equity funds, I'd suggest starting with 1.0%. For bond funds, try 0.5%.

5) By this point, you've already made significant progress in your search for low-
cost funds. Morningstar.com's Premium Membership service can help you do additional research on costs using the following three tools.

a) Similar Funds: This tool helps you quickly and easily find better funds than you currently own.

Within Similar Funds, type in the ticker of a fund you own, and check all three boxes next to the ticker box. This limits your search to no-load funds that are open to new investors, and which have expense ratios less than the category average. If the fund you already own is
among the lowest-cost funds near the top of the list, congratulations. If not, click on the fund names to do further research on the cheaper funds.

b) Cost Analyzer: This tool allows you to directly compare how much two funds will cost you over your investment horizon.

Here's how it works: Let's say I use Cost Analyzer to compare two similar funds: Templeton Developing Markets and T. Rowe Price Emerging Markets . If I replace the Templeton fund with the T. Rowe Price fund, Cost Analyzer tells me that my total savings over the next 15 years is substantial: more than $4,000 on an original investment of $10,000.

c) Trade Analyzer: See if the cost savings outweigh the trading
costs.

This tool, another benefit of Premium Membership, allows you to weigh taxes, commissions, and different expense ratios before making your buy/sell decisions.

Learn More
We're cheapskates at Morningstar, and we've written many articles about fund fees and other ways to save money. Here are some of our favorites.

Four Funds with Falling Fees
by David Kathman

Your Fund's Hidden Costs
by Emily Hall

Bond Funds Bucking the Higher-Fee Trend
by Eric Jacobson

Applauding Funds that Cut Costs
by Eric Jacobson

Fund Fees and Your Bottom Line
by Kerry O'Boyle