By WARREN BOROSON
(Morris County, N.J.) Daily Record

Interesting conversation overheard recently between a certified public accountant and a certified financial planner:

CPA: How can I tell whether a mutual fund will perform well in the future?

CFP: Expenses are key. Funds with low expenses are more likely to do well than funds with high expenses.

CPA: Gee, I thought that "you get what you pay for." If you pay up for something, you get something better. A car or a camera.

CFP: Generally that's true. But the world of mutual funds is an exception. The more you pay, the worse you're likely to do.

That's not always the case. Legg Mason Value Prime is expensive - but it's done terrifically.

What we're talking about is "rationality in pricing."

Normally, as the CPA noted, the better an item is, the more you will pay. A Mercedes costs more than a Honda. A meal at the Quilted Giraffe costs more than one at McDonald's.

The best reasons to buy a fund are that it has a fine long-term record, and the manager responsible for that record is still in place. After that, you should consider whether it has sales charges, its expenses, how volatile it has been, how far down it has fallen in bear markets and whether it seems to be getting too big for its own good.

Low expenses are important but not all-important. They are the appetizer - a vital part of the meal but not the main course.

Of course, bargains exist. The generic form of a drug is almost always just as good as the brand-name version.

As Consumer Reports regularly tells us, sometimes the most expensive product is not as good as a much less expensive one.

In the July 2004 issue, rating 12 canister vacuum cleaners, Consumer Reports puts two Kenmores at the top, and each costs $230. At the bottom is the Rainbow, which costs $1,800 - the priciest model. Also, in rating 13 adult bicycle helmets, Consumer Reports put a Louis Garneau, going for $45, in first place. In fourth place, a Giro for $140. In 12th place, a Bell for $80.

But the argument can be made that, even in the world of mutual funds, what's better should logically cost more.

After all, if a portfolio manager is skillful and his fund does well, won't he or she want to be better paid than other portfolio managers? Especially if his/her fund and his/her fund family are big and money-making? And so won't his or her analysts and other co-workers also expect to be properly rewarded?

Don't you think that Robert Stansky at gargantuan Fidelity Magellan expects a higher salary than someone who runs a small, poor-performing fund?

Besides, not all cheap funds are good funds. Pioneer Europe A, for example, has a tiny expense ratio of 0.76 percent, whereas the average expense ratio of European stock funds, according to Morningstar, is 1.95 percent. And Pioneer Europe A gets one measly star from Morningstar - the lowest possible rating. (Granted, funds with one-star ratings and low expenses are not common.)

So, why do funds with low expenses generally do well?

One answer is: It's the result, not the cause. Post hoc, ergo propter hoc. It's the fallacy that just because B comes after A, A must have caused B.

As a fund does well, more people invest. And as the fund becomes larger, it begins to enjoy economies of scale. You get a price break when you buy 10,000 envelopes instead of just 1,000. That's why, as funds grow larger, they usually lower their expenses. In other words, successful funds tend to have low expenses because they are successful.

The same goes for unsuccessful funds. As they continue to do poorly, investors flee - and the fund begins to suffer from the opposite of economies of scale. You don't get a price break when you order 1,000 envelopes instead of 10,000.

Two other illustrations that successful funds tend to have low expenses: Vanguard and index funds.

Vanguard is a fund family with extraordinary low expenses - in part because Vanguard offers so many cheap-as-dirt index funds. And index funds in general do well (in part because of their low expenses). But Vanguard's actively managed funds also do well, even with somewhat higher expenses.

So the Vanguard funds lift up the performances of funds in general that have low expenses.

Skeptical?

What if there were no Vanguard funds? Wouldn't the higher expenses of Fidelity and other non-Vanguard fund families push up the average expense ratios of successful funds in general?

Finally, directors of mutual funds typically have not punished poor-performing funds. In fact, they tend to approve raising the expenses of such funds, possibly to compensate for all the money that has been leaving the fund.