Recently, I participated in an online conversation about mutual funds. Some people said that they use target retirement funds, as well as “funds of funds.” Nearly every person mentioned that they have some mutual funds in their investment portfolio. Even though I also have some mutual funds in my 401k (due to my plan offering limited investment choices), I am usually cautious about investing in mutual funds. Here is my comment in that discussion forum:

Be careful of target date funds, since they have layered expense ratios (these are funds that charge you for containing other funds which in turn charge their own fees). Also if you are paying your adviser to pick mutual funds, you are paying him or her to pick mutual fund managers who charge you too. Then, if you pay your adviser and he or she puts you in a fund of funds, you are in effect paying 3 fees – to the adviser, to the fund of funds and to the constituent funds. Also, unless the mutual fund manager invests his or her money alongside you, your interests are not truly aligned. Wall street can fleece you at every turn.

So what can you do to minimize your investment expenses?

1. Invest in individual securities. By assembling your own portfolio of great businesses, not only do you have control over which securities you invest in, but you pay only broker’s commissions and no management fees. Investing in individual securities can carry additional risk.
2. Sometimes, investing in mutual funds or exchange-traded funds (ETFs) is easy and convenient. Additionally, it may allow one to access the markets where it is difficult and/or expensive to trade individual securities. In these cases, one will do well to seek out low expense ratio mutual funds and ETFs. Usually, I see no compelling reason to invest in funds with front or back loads (sales charges), funds of funds or target retirement funds. Fidelity Spartan and Vanguard funds usually fit the bill.
3. Use a discount broker. Here’s how to choose an online discount broker. Here’s Barron’s 2011 Broker Review. This is Barron’s 2011 Broker Review in table format. Pay attention to all the fees a broker charges, not just commissions.
4. If you use an investment adviser, pay only what’s reasonable. I think your total fees should not significantly exceed 1% of your assets under management. This includes the advisory fees and trading commissions.