investing

Win With Low-Cost Mutual Funds

Paying a high price for a mutual fund doesn't guarantee better performance.

A new study by Morningstar found that low-cost funds beat high-cost funds in every time period and data point tested. Not only did funds with the highest expense ratios produce lower returns than funds with the lowest expense ratios, but also they were more likely to be liquidated or merged away.

All funds charge investors for expenses, which include management fees and other costs of doing business, such as legal and accounting. Those ongoing fees are expressed in a term known as the annual expense ratio -- the percentage of assets that go toward operating a fund. These expenses are subtracted directly from a fund's assets. The higher the ratio, the less is left over for you.

"Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance," writes Russel Kinnel, director of mutual fund research with Morningstar and a Kiplinger columnist. "Start by focusing on funds in the cheapest or two cheapest quintiles, and you'll be on the path to success."

For Kiplinger's picks for the best low-cost funds, see Our 25 Favorite Funds. We also combine these funds into portfolios to help you meet your goals.

See our 2010 Mutual Fund Rankings to find out which funds topped their categories and which we think will perform well in the future.

Exchange-traded funds are another low-cost option. The expense ratio of a typical ETF that invests in large growing companies, such as iShares Russell 1000 Growth Index, is a mere 0.20%. That means for every $1,000 you have invested in the fund, you pay just $2 in expenses annually. See Exchange-Traded Funds: A Primer to learn more.

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