Sticker Shock

I think the expense ratios are too high in two funds I own. Am I paying too much?

QUESTION: I currently have two funds -- USAA Balanced Strategy (USBSX) and T. Rowe Price Capital Appreciation (PRWCX) -- and I think I'm paying too much in expense fees. What do you think?

-- Ken Reed

ANSWER: A hefty expense ratio doesn't seem to hurt so much when returns are shooting through the roof. But in a bear market you'll definitely feel the bite of high fees. That's why expenses should always be a consideration when evaluating funds for your portfolio, regardless of performance. "People are not as attuned to costs as much as they should be," says Scott Cooley, a senior analyst at Morningstar.

Looking at expense ratio averages is a good way to figure out if you're paying too much in fees. Expense ratios for the USAA Balanced Strategy and the T. Rowe Price Capital Appreciation funds are 1.23% and 0.87%, respectively, which fall well under the 1.37% average for all domestic equity funds, according to Morningstar data.

Even more important, however, is the average expense ratio within the fund's category. Certain categories of funds have higher expense ratios because of the higher costs necessary to run them. For example, emerging-market funds are some of the most expensive around, with an average expense ratio of 2.08%. They require much more research than the average fund, since corporate financial disclosure standards aren't as strict in emerging markets, says Cooley.

The good news for you is that both funds you mention fall into Morningstar's domestic hybrid category, where the average expense ratio is 1.27%. Both of your funds have lower fees.

Another useful but less accessible number is the category's median expense ratio. The median figure might even be more helpful than the category average because extremes on either end can skew the average higher or lower, says Jeff Keil, a vice president of the board analysis services group at Lipper. According to Lipper, the median expense ratio for balanced/mixed equity funds (the category roughly corresponding to Morninstar's domestic hybrid funds) is 1.25%. More good news for you.

You should also be looking out for the relationship between the expense ratio and asset size. Generally, the larger the fund, the lower the expense ratio, since costs are spread out over a larger asset base, says Cooley. For example, the Vanguard 500 Index fund (VFINX), which holds more than $72 billion in assets, has a bargain-basement expense ratio of 0.18%.

While most funds have a set fee for the cost of managing them, some, like Fidelity Magellan (FMAGX), have chosen to adopt performance-based fees that swing up or down based on the manager's performance against a benchmark (the Standard & Poor's 500, in Magellan's case). That's a good idea because it aligns the financial interest of the shareholder with that of the money managers, says Matthew Sadler, president and chief executive of Quintara Funds and an advocate of performance-based fees.

Unfortunately, details on fund expenses aren't as easily accessible as they should be. The returns you see on your mutual funds' annual reports are after any administrative, 12b-1 or management fees. Your fund prospectus will provide a fee table that shows sample dollar-amount fees based on a $10,000 investment and 5% annual return over various time periods. But it's up to you to compute the amount you've actually paid in fees. Check out our fund fee analyzer for some help.