updated 12/22/2003 2:17:16 PM ET 2003-12-22T19:17:16

Most mutual fund investors don't know how much they're paying to have their money managed. What's worse is that they mostly don't care.

Dennis Ellman ought to know a thing or two about money managers. For 15 years he handled public relations for a good one, Charles Brandes, a value-stock picker in San Diego. But in early 2000 Ellman allowed his PaineWebber broker to put all of his $110,000 portfolio into the Pimco PEA Innovation technology fund.

No, it isn't the bad timing that we're talking about. It's the fact that Ellman didn't know what kind of fees he was paying to have his money managed. He wasn't aware of the 5.5% sales commission to get in. He had no way to judge whether the fund's expense ratio of 1.3% was reasonable compared with the cost of other tech funds; he didn't even look at the number, which was in the prospectus.

Ellman's biggest patch of ignorance may have been his notion that you get what you pay for in money management--that high-ticket providers are more likely to deliver quality than discounters. "I don't pay the average price for an electrician," he says. "I don't pay below average, either. I hire the best electrician and pay more for it. I'll pay more for a great stock picker, too."

He's getting an education now. The meltdown in tech stocks, coupled with the fees and the sales commission, has shrunk his investment by 63%, to $41,000.

In being a little fuzzy-headed about fees and what they do to investments over time, Ellman has a fair amount of company. According to the Securities & Exchange Commission, a sixth of fund investors don't understand that higher fees can impair performance. Only a fifth of them can estimate the fees and expenses of their largest mutual fund holding. Like Ellman, investors are concerned primarily with performance. An Investment Company Institute study finds that only 43% of mutual fund investors even consider management fees and sales charges when picking their funds.

Of course, if high fees brought better results, we could all retire rich. Alas, the reverse is more often the case. The cheapskate Vanguard 500 Index fund, run without any attempt at cleverness in stock picking, has beaten 73% of all equity funds over the past ten years.

Robert Ganser, a 51-year-old business consultant in Stamford, Conn., had held the Fidelity Dividend Growth fund for years, but after what he perceived as Fidelity's impersonal treatment of its investors, he decided to hire a broker at A.G. Edwards. The broker put Ganser into the Hartford Dividend and Growth fund. Ganser says he didn't notice the 5.5% sales charge until he transferred his $15,000 and then noticed his account balance was $825 less than he'd expected.

"I'm sure they made mention of the charge somewhere, but I feel like it should have been presented to me directly," he says.

Ganser should have stayed put. Fidelity was giving him a good deal, with a fund that charged him no sales commission and ran the money for a 1% yearly fee. Hartford's expense ratio is 1.4%. The two funds have done almost exactly the same over the past five years, before fees. But the drag of higher fees is visible. The Fidelity fund netted a 2.4% annual return over that time; the Hartford fund's average was only 2.2%.

Do you know exactly what costs are included in the annual expense ratio? (It covers the costs of portfolio management, servicing shareholders and overhead, but not trading commissions.) Do you know whether performance numbers are reported before or after subtracting these costs? (After.)

Don't be embarrassed about not being able to answer these questions, which even stump experts. Linda T. Mead, author of Investing With Giants, guessed the answer to the second question wrong in an online seminar she ran last year to promote the book.

But you should be ashamed to buy a fund without even looking at the expense-disclosure page. That's like deciding on a car purchase without knowing the sticker price. Philip Edwards, who oversees fund analysis at Standard & Poor's, says the level of ignorance--and apathy--would diminish if funds had to translate the percentage costs into dollar terms in quarterly account statements. That may happen (see "Bright Ideas").

© 2012


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