Too Revealing?

The scoop on funds of funds.
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This story appears in the June 2007 issue of Entrepreneur. Subscribe »
Funds of funds--which spread their investment dollars across other mutual funds rather than stocks or bonds--have gained a significant following in recent years. Life-style funds and targeted-maturity funds in particular have been popping up in retirement accounts from coast to coast.

But in the name of transparency, an SEC rule that went into effect July 31, 2006, threatens to put the brakes on that growth. The new rule mandates that starting in 2007, fund companies must include in their expense ratios not only their top-line management fees, but also the underlying costs of the funds in which they invest. In other words, the (fictional) Generic Fund might charge you 1.5 percent in expenses to assemble a portfolio of other funds. And that's all it would have listed in the expense ratio last year. But this year, Generic Fund will also have to break out the expense ratios of the funds in which it invests your dollars, which might bump the total up to 4 percent. Even though nothing about the fund management changed, it looks more expensive on paper.

Heavies like Fidelity Investments, T. Rowe Price and Vanguard can rig the system by investing only in their own funds and waiving management fees--so their funds of funds look (and, in fact, are) cheaper than competitors' offerings. But your boutique fund's all-in-one asset allocation doesn't really cost you more than last year, despite appearances to the contrary. So if the higher expense ratio makes you squirm, you probably shouldn't have invested there in the first place.

Edition: July 2017

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