Fees and expenses can take a significant bite out of your mutual fund gains without you realizing the impact, since most of the fees are taken off the top. They may not be that noticeable, since you are never forced to write checks to see the amounts, but they can be painful. A seemingly innocuous 1% fee can have a striking effect over time, especially during times of low return. Understanding how to assess and compare fees is key to minimizing your expenses. You can locate these fees in the front of your fund’s prospectus under the heading “Shareholder Fees.”
What are the types of mutual fund fees? Here are the typical categories (fee names may differ between funds):
- Sales Load – When a fund uses a broker to sell shares, it typically compensates the broker through a fee charged to investors called a sales load or sales charge load. There are two kinds of sales loads: a “front-end” load that investors pay at time of shares purchase and a “back-end” load investors pay when shares are redeemed. Sales loads can run as high as 8%, so they must be taken into consideration. Understandably, “no-load” mutual funds are popular because they do not assess a sales charge.
- Management Fees – These cover portfolio advisory costs incurred by the investment company, including securities research and compensation to investment managers. Typical management fees are 0.5% to 2.0%, depending on the complexity of managing the fund. It is wise to check these fees and see if they are proportionate with the type of investment and the expected return. For example, international funds may require worldwide staffing and use foreign currency purchases as a hedge, so it is logical that the expenses and risk would be higher in those cases. Index funds, on the other hand, are extremely easy to manage, and should generally charge lower fees.
- 12b-1 Fees – These are marketing and advertising/promotion fees. Some funds refund these fees to investors, but the majority do not refund.
- Legal Fees – Typically a small (but necessary) component of expenses, these fees are used for such things as filing SEC paperwork and handling other regulatory expenses.
- Custody Costs – Costs associated with the custodian bank for tasks like registering the stocks and bonds, handling the cost accounting, and collecting interest or dividend income.
- Transaction costs – These are fees that are paid to the fund to handle costs associated with fund transactions, as opposed to "loads" that are paid to a broker or other sales intermediary. They may be purchase fees that are paid up front as a percentage of the investment, or as a redemption fee when you sell fund shares. There may also be exchange fees for transferring within a fund or the same family of funds.
- Maintenance Fees – May be assessed on an account if the account holder fails to maintain a minimum account balance.
When you study the fee table shown in your fund’s prospectus, you should look at the Expense Ratio, which is defined as the total of all operating expenses (typically expressed as a percentage of average net assets). Comparing expense ratios of different funds allows you to choose a fund with a relatively low expense ratio, and the rest of the fee table allows you to look at the individual fees to see if they are proportionate with the expected risk, return, and management headaches.
Choosing a mutual fund with low fees, such as “no load” and “indexed” mutual funds is a viable way to help boost net returns, but that should not be your only criterion. You must also consider the historical returns of each fund, as well as the sector(s) targeted by the fund (such as Industrials, Financials, Energy, or Technology sectors) if you are investing in a stock mutual fund. Your goal is to achieve the highest total return from a mutual fund investment. Fees are just one factor – albeit an important one – in mutual fund selection.