The fund management industry is among the most profitable. But the industry’s fee-charging practices are not without critics. As one cynical observer put it, paraphrasing Winston Churchill: “Never in the course of history have so many paid so much to so few for so little.”

At the most extreme end of the fee-charging spectrum are private equity funds and hedge funds. Private equity funds normally charge investors a management fee based on the value of the assets under their management, a performance fee based on the actual performance of the fund, plus transaction fees every time the fund buys or sells an investment. Hedge funds have become known for their “2 and 20” charging structure, which means a 2% management fee plus 20% of all gains above a certain hurdle rate.

Mutual-fund fees never reached the extremes of hedge funds or private equity funds. But they still manage to charge rich fees linked to the value of the assets under management. As markets generally rise over time, so do fund assets. As a result, managers earn more without having to do any more work.

Now, most people would accept high fees if managers performed better than their passive benchmarks. Unfortunately for the asset management industry, this has not been the case. Numerous studies have demonstrated that the average investment manager cannot beat standard benchmarks after costs have been taken into account. The table demonstrates how dismally the average U.S. mutual fund manager failed over the past 30 years.

The 1.6% annual performance gap is almost fully explained by the fees charged by fund managers. The fact that many mutual fund managers became closet benchmark trackers with little variation from their respective benchmarks compounded their problems. The average fund manager, with a portfolio that closely resembled the benchmark index and loaded with fees, is almost guaranteed to underperform.

Unsurprisingly, actively managed mutual funds have been losing customers hand over fist to cheaper products that delivered better after-cost returns. The market share of passive index tracking mutual funds has grown from 4% to 34% over the past 20 years, and a new generation of index tracking funds — exchange traded funds (ETFs) — is also rapidly capturing market share from traditional “active” mutual funds.

How should investors allocate their overall portfolios given these trends? Here are some pointers:

Fees play a very important role in investor returns over the long term. The graph demonstrates how investment returns of a mutual fund that charges fees of 1.1% of assets compares to a low-cost index fund or ETF, as well as to a flat fee newsletter advisory service. Note that our expected return assumptions for all three groups are the same, but the fee assumptions are different and reflect current market averages.

Unsurprisingly, the flat fee newsletter advisory service comes out on top as the fee for the service does not increase as the investor’s assets grow. This also implies that the investment returns accrue every year to a higher starting value which allows for a much better compounding effect over time.

From a starting value of $250,000, the final newsletter advisory portfolio value exceeds the mutual fund value by $1 million (or 37%), measured over a 30-year period. That’s a staggering amount that should accrue to the investor rather than to a mutual fund manager that can’t beat his benchmark. ETFs and passive index-tracking mutual funds perform better than active mutual funds because of the cost advantage, but they lag the performance of the flat fee service as even the modest fees of ETFs reduce the positive compounding effect.

Some investors may argue that they have uncovered better-than-average fund managers that even after costs provide better returns than the benchmark index or comparable ETF.

Now of course, that is a plausible outcome. There are some excellent fund managers, but research from Morningstar indicates that the chances of picking a manager that will perform better than the benchmark over time is slim. In fact, over the past 10 years, less than 20% of U.S. large cap mutual fund managers succeeded in doing that. Mid cap, small cap and emerging market mutual fund managers fared somewhat better, but investors’ odds of picking the right managers remain limited.

Our suggestion is simply that investors should be acutely aware of visible and hidden fees included in the funds or other products used to construct their long term investment portfolios. Ideally, they should find a low-cost index fund as a core holding supplemented by a newsletter service or advisor that will effectively charge a flat fee for a quality advice.