Mutual Fund Fee Lawsuit Heads toward Supreme Court

Here’s a story that caught my attention as an investor:

Nov. 2 (Bloomberg) -- John Bogle helped create a mutual-fund industry that has grown to $10 trillion in assets. Now the Vanguard Group Inc. founder is backing investors asking the U.S. Supreme Court to limit the fees charged by fund managers…
The dispute pits the fund industry against trial lawyers, consumer-rights groups and Bogle, an industry pioneer who started Vanguard in 1974. Bogle, who filed a brief supporting the Oakmark investors, says mutual fund shareholders are being overcharged with fees that seem low when expressed as percentages yet add up to a multibillion-dollar windfall for advisers.

Emphasis on the last sentence mine. So let’s unpack this. It’s no secret that the mutual fund companies charge high fees for managing their funds. Called an expensive ratio, it’s the management fee the company charges for “taking care of your money.” The article is right that these companies take up to 1.5%, some more, of your returns (or lack of returns) as a fee.

This demands a closer look. Let’s say the S&P 500 returns 5% this year. If a mutual fund company gains you 6%, (1% above the market from your investment over last year) they will deduct 1.5% of it leaving you with and effective 4.5% return. If they LOSE 6%, they STILL deduct 1.5%, leaving you with a 7.5% loss. And don’t forget that “stellar” track record that actively managed mutual funds have. But “what difference does 1% or so make over the long term?” you may ask. After all, you get to keep the other 99%, right? Well:

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

This is what the plaintiffs are fighting against. I’m a bit unsure of what they want to happen (certainly they don’t want the feds setting profit rates). I think there is still a large enough amount of mutual fund companies out there where consumers can shop around for a balance of cost and service.