Mutual Fund Fees
Mutual funds are the most popular choice for diversified
funds in today's marketplace (though ETFs are fast on the rise, and MLP’s,
REITS, BDC’s can be better due to having both dividend and value growth
potential). However, for all of their popularity, some investors still do not
fully understand the fee structure and all of the possible charges that can be
associated with investing in one of these products, and this is what I would
like to share with you this week.
•Expense Ratio: The most obvious and up-front cost, an
expense ratio or management fee, is paid each year to the fund's management
team out of the fund's assets. The average mutual fund charges 1.3% to 1.5%
each year, which can add up quickly and eat up your position over time. When stated as a percentage of assets,
average fees do look low — a little over 1% of assets for individuals and a
little less than one-half of 1% for institutional investors. But the investors
already own those assets, so investment management fees should really be based
on what investors are getting in the returns that managers produce. Calculated
correctly, as a percentage of returns, fees no longer look low. Do the math. If
returns average, say, 8% a year, then those same fees are not 1% or one-half of
1%. They are much higher — typically over 12% for individuals and 6% for
institutions.
•Transaction Fees: Most funds will charge a fee when making
your initial purchase and some will also charge a redemption fee, which comes
when you sell the fund. Both of these fees are paid to the fund, making them
different charges than the next two items on our list.
•Front-end Load: This is a fee charged at the purchase of
some funds; it is paid to the brokers that sell you the product. A front load
is usually charged as a percentage and comes out of your initial investment. If
you were to buy $10,000 worth of a fund that charged a 3% front-end load, $300
would go to the broker, while $9,700 would actually be invested.
•Back-end Load: This works the same way as a front-end fee,
but it is charged when you sell certain funds. Back-end fees typically taper
off as time goes on; for example, the fund can charge 3% if you sell within one
year, 2% within two years and so on. These typically won't hurt a long-term
investor, but they can be a nasty surprise if you need to exit a position
earlier than anticipated.
A no-load fund sells its shares without a commission or
sales charge. Some in the mutual fund industry will tell you that the load is
the fee that pays for the service of a broker choosing the correct fund for
you. According to this argument, your returns will be higher because the
professional advice put you into a better fund. There is little to no evidence
that shows a correlation between load funds and superior performance. In fact,
when you take the fees into account, the average load fund performs worse than
a no-load fund.
•Account Fees: Certain companies will charge investors an
account fee, which is a cost associated with the maintenance of an account. These
include necessities such as postage, record keeping, customer service,
cappuccino machines, etc. Some funds are excellent at minimizing these costs
while others (the ones with the cappuccino machines in the office) are not.
• The last part of the ongoing fee (in the United States
anyway) is known as the 12B-1 fee. This expense goes toward paying brokerage commissions
and toward advertising and promoting the fund. That's right, if you invest in a
fund with a 12B-1 fee, you are paying for the fund to run commercials and sell
itself!
Not all mutual funds will incur the
aforementioned fees, and there are plenty of options that manage these costs
quite well. Still, investors should watch out for the fee structure associated
with any mutual funds they purchase and be sure that they understand the costs
associated with the investment. If a fund has a fee structure that you are not
comfortable with, try looking into ETF’s, REITS, MLP’s & BDC’s, those
products are often more cost effective and still offer most of the advantages
associated with mutual funds, to include dividend growth and greater value
growth potential.
Happy Investing
Suburbantrader.info
Disclaimer: Suburban Trader is a publisher of financial
news and opinions and NOT a securities broker/dealer or an investment
adviser. You are responsible for your
own investment decisions. All
information contained in our newsletters or on our web site(s) should be
independently verified with the companies mentioned, and readers should always
conduct their own research and due diligence.
