A new Vanguard study on mutual fund and exchange-traded fund (ETF) purchasing activity revealed that lower-cost products have attracted the predominant portion of investor dollars over the past decade.

In “Costs Matter: Are Fund Investors Voting With Their Feet?,” Vanguard found that in each of five categories, investors favored funds with lower expenses, directing between 55% and 93% of cumulative net cash flow to the lowest-expense quartile of funds.

“It is clear from our analysis that investors are increasingly gravitating toward low-cost funds and ETFs,” said Francis Kinniry, Jr., Principal, Vanguard Investment Strategy Group. “The trend to low-expense funds is very encouraging. Low investment costs, along with time and savings rate, should be the focal points for investors as they seek to accumulate sufficient wealth for retirement. Costs are also important to the retired investor, as high costs can substantially reduce one’s income stream and principal balance over time.”

Mr. Kinniry noted that the growing popularity and availability of index funds and index-based ETFs likely fueled the flight to low-cost products. He also noted that a similar shift took place among actively managed funds, as lower-cost active equity funds attracted more assets relative to their higher-cost counterparts.

The paper also discussed several other reasons for the movement toward lower-cost funds, including:

- The large role that financial advisors and corporate retirement plan sponsors play in the fund distribution process. Some 80% of fund assets are held through these intermediaries, which are increasingly offering low-cost products to their clients and participants, respectively (Source: Investment Company Institute, 2009). In the advisor market, a move from a transaction-oriented, commissioned-based model to a fee-based model likely abetted the low-cost trend.

- A volatile financial market environment that led to greater recognition by investors that 1) costs matter and 2) costs are a controllable factor in the investing equation. By contrast, the historically generous stock and bond returns of the 1980s and 1990s resulted in investors focusing on high absolute returns and paying little attention to costs.

- Increased investor understanding of cost, which was aided substantially by improved disclosure, the greater availability of cost information online, heightened scrutiny of costs by the financial media, and the emergence of costs as a selling point in fund marketing efforts.