Top5 Low-Cost Mutual Funds

By Rob Wherry,
Senior Writer,

IF YOU INVEST IN mutual funds, you must pay attention to fees. It's as simple as that. "If you can just shave off 50 basis points from your fees it winds up being thousands of dollars [over the life of the account.]," says Tom Roseen, a senior analyst at Lipper.

To make it easier on you, we've selected seven stellar low-fee funds that also deliver terrific returns. If you're looking to put a little money into the market, these solid earners that don't cost an arm and a leg are worth your consideration.

1. Index Funds

If you don't want a lot of flash -- or have the time to weed through mountains of prospectuses -- we suggest going with a broad market index fund. These offerings are designed to track the results of a benchmark like the S&P 500 index. Experts like Vanguard's John Bogle champion index funds because most actively managed funds fail to beat the S&P 500. He has a point. But we favor them for a far simpler reason: They are easy to use and understand.

Since index products are relatively static they feature little turnover that can trigger capital gains and they charge the lowest fees in the mutual-fund world. But they aren't perfect. While in concept, index investing should allow you to kick up your heels and relax, you do need to keep an eye on them during bull markets. Most index funds are weighted according to a company's market capitalization. When stocks take off -- as they did during the tech boom -- this strategy can lead to a fund full of overpriced stocks bid up by giddy investors.

One of our favorites -- and a frequent inclusion in 401(k) plans -- is the Fidelity Spartan 500 index fund (FSMKX), which invests in the market's largest companies, like Exxon Mobil (XOM), General Electric (GE), Citigroup (C), Bank of America (BAC) and Microsoft (MSFT). Over the last 10 years it has returned 7.9% annually (as of Dec. 13, 2006), vs. 8.1% for the S&P. That slight gap is due, in part, to the 0.10% expense ratio.

Another is the Vanguard Total Stock Market fund (VTSMX). It invests in 3,700 companies, giving it more exposure to potentially faster-growing smaller companies that aren't members of the S&P 500. It has returned 10.9% annually since its inception in 1992.

2. Exchange-Traded Funds

OK, so exchange-traded funds, or ETFs, aren't quite the same thing as a mutual fund. But they're similar. (Click here for a tutorial on exchange-traded funds.) Exchange-traded funds invest in the same underlying stocks as their comparable index funds, but unlike mutual funds, they trade during the day. Exchange-traded funds have been around for two decades, but they began to take off after the tech bust when investors grew dismayed with poor performance and the subsequent mutual-fund scandals. According to State Street, one of the leading ETF providers, today there are 344 ETFs holding $407 billion in assets. Just last year there were 201 ETFs with $296 billion. That's quite a jump.

In the rush to join a red-hot market, many ETF providers have launched what we would call flavor-of-the-month funds. Let's face it: You probably don't need an ETF that specializes in spinoffs or the environment. Our approach with ETFs is much like it is with index funds: Invest in well-diversified ones with low fees and good performance.

We would go with the ETF versions of the index funds we mentioned in our first point. The ETF equivalent of the S&P 500 -- nicknamed Spiders -- charges just 0.06% a year in fees; Vanguard's Total Stock Market ETF (VTI) has a 0.05% expense ratio. "If you are looking for simple stock market exposure you can't go wrong with these funds," says Morningstar's Dan Culloton.


3. Growth Funds

Bill Frels has never strayed too far from home. He grew up in Superior, Wis., attended the state university in Madison, and eventually headed to the Twin Cities, where he now runs the Mairs & Power Growth fund (MPGFX). He also doesn't venture far to find his best investing ideas. Frels's fund has returned 12% annually over the last decade -- four percentage points better than the S&P 500 -- by investing largely in companies that are headquartered in the Minnesota area. He's plainspoken, genuine and probably one of the best stock pickers of his generation.

There's another reason why we like Frels: He's cheap -- or at least his fund is. Mairs & Power Growth doesn't whack investors with a sales charge and its annual expenses -- $7 annually for every $1,000 invested -- are half those charged by the typical domestic-equity fund. Kerry O'Boyle, who follows the fund for Morningstar, likes the patient, long-term focus. "Mairs & Power Growth has the right stuff," he wrote in a recent report on the fund.

Frels is what we would consider a classic growth manager. He searches for stocks that have an estimated 10% to 12% earnings growth rate. But he doesn't like to overpay for them. He passes on a company when its price/earnings ratio is more than twice that growth rate. Surprisingly, his narrow universe of stocks headquartered around his hometown of St. Paul, Minn., hasn't held him back. His top holdings include Wells Fargo (WFC), Target (TGT), Emerson Electric (EMR), 3M (MMM) and Medtronic (MDT).

4. Value Funds

Brian Rogers, manager of the T. Rowe Price Equity Income fund (PRFDX) since 1985, is a classic value manager. He wants financially sound companies that are trading at a discount to their fair value -- particularly on a price/earnings ratio level -- maybe because investors have reacted negatively to some bad news. Short term, the stock may look like a loser. But Rogers is more concerned about the long view.

Many investors crave equity income funds for one reason: dividends. As baby boomers head for retirement, they have come to appreciate the extra income a healthy dividend yield can provide. Indeed, over time dividends have accounted for around half of the historical total returns of the S&P 500. T. Rowe Equity Income has a dividend yield of 2.4%, about 30% higher than the yield on the S&P.

But Rogers also has performance on his side. His fund's top holdings include JP Morgan (JPM), Exxon Mobil (XOM), Morgan Stanley (MS), and Colgate-Palmolive (CL). This year he is up 18.4%. That's in line with this category: Lipper says equity income funds have gained 16.4% year-to-date, tops of any equity fund sector.

5. International Funds

Most folks should have at least part of their portfolio invested abroad. As the growth rate here in the U.S. has cooled recently, stock markets in Asia, India and Europe have been humming along. Financial planners now suggest putting as much as 20% of your assets into funds that specialize in investing overseas.

International funds can cost more -- after all, they do need to fly around the globe, hire translators or researchers. But don't let fees in this category get too high. Indeed, our favorite pick is Dodge & Cox International Stock (DODFX), which charges a measly 0.70% expense ratio. The managers here favor well-run companies that are undervalued despite clean balance sheets. Top holdings include GlaxoSmithKline (GSK), Royal Dutch Shell [RDS.A] and Honda (HMC). The fund has returned 21% annually over the last five years. But you might want to hurry if you like this fund. At $26 billion in assets Dodge & Cox, which has closed funds in the past, might pull the trigger on this one as well.

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