Nearing Retirement

Mutual Fund Fees and Your Market Basket

Many fund companies display their performance figures prominently, but they may take a low-key approach when it comes to mutual fund fees. Generally, when funds are doing well and returns are strong, investors tend to overlook the fees charged by mutual funds. However, regardless of the performance of your investments, you should understand what fees are charged and how much they will cost you.

Understanding the fee structure of your fund(s) will help you realize the amount you’re paying for professional management and provide insight into how efficient fund management is. It also allows you to make realistic comparisons between several mutual funds or between a mutual fund and another investment. Fees are something to consider but overall long-term performance is what investors are most concerned with.

All Fees are Not the Same
There are four basic costs that can impact mutual fund returns: fees for managing the fund; brokerage costs incurred when trading securities; front-end or back-end loads (sales charges); and 12b-1 fees. These fees, when applicable, are detailed in a mutual fund’s prospectus.

Every mutual fund charges fees for fund management, custodianship, and market auditing. The day-to- day expenses of running the fund are paid from these fees. The expense ratio—a measure of these fees compared to the total assets of the fund—is usually expressed as a percentage of assets under management (e.g., 1.5% for a domestic stock fund). In addition, some funds trade securities often and have high brokerage costs, while others control brokerage costs through infrequent trading.

Sales loads vary and may, or may not, be part of a fund’s fee structure (i.e., funds may be high-load, low-load, or no-load). Loads are further categorized by when they are incurred. If a fund imposes a front-end load, the charge is taken from the amount invested. For example, a fund with a 5% front-end load would take $50 out of a $1,000 investment. The investor’s account would reflect a beginning balance of $950.

Back-end loads are levied when shares are sold (also called redemption). For example, a fund with a 5% back-end load would take $50 out of a $1,000 redemption. Some funds use redemption fees to discourage short-term trading and protect longer-term investors. For example, they will impose a sliding scale of sales charges, so that the longer the investor remains in the fund, the lower the charge to redeem shares.

The 12b-1 fee permits a fund to use a percentage of fund assets to pay certain costs, such as for advertising and distributing fund literature (prospectuses and annual reports). Some funds use 12b-1 fees as hidden loads—that is, they use the money to pay commissions to brokers, rather than imposing front-end loads. Since 12b-1 fees are charged annually, they can result in a total cost to the long-term investor that exceeds a high front-end load.

Be Sure to Compare
The popularity of mutual funds has prompted many investors to forgo other traditional savings mechanisms in favor of funds yielding higher returns. However, as you have just seen, the various fees charged by mutual fund companies can add up significantly over time.

Does this mean that you should eliminate mutual funds from your portfolio? Not at all. What it does mean, however, is that you must carefully analyze your current mutual fund earnings—less fees—and compare them with other options offering similar objectives and risk exposures. High fees can have a negative impact on your portfolio’s overall performance.

Fe, Fi, Fo, Fees!
In general terms, avoiding funds with high expenses is one way to help improve the bottom line of your investments. At the same time, it is also important to recognize that “fees” are just one of many factors to consider when pondering the addition (or subtraction) of a mutual fund to (or from) your portfolio. Therefore, use this mutual fund fee primer as a springboard to reviewing your current savings and investments. By staying on top of mutual fund fees, you can better understand which investment and savings vehicles are appropriate for your situation.