Mutual funds are a widely popular form of investing in the financial markets, and can be found in many 401(k), IRA, Roth IRA, and brokerage accounts. They can provide a huge help to you in investing for the future, but do you know everything you pay for that help?
Please keep in mind, you will find these fees disclosed in the prospectus for every fund, but unless you spend your time reviewing those prospectuses and account statements, they may have slipped your attention.
The three main expenses to look up:
Technically, this represents the costs to manage the fund as a percentage of the overall assets in the fund. You never really “see” it in your account statements because the fund company removes it from the rate of return reported to you.
Example: You have money in Fund XYZ with an expense ratio of 1%. The fund earns 8% for you. However, the return you receive would be 7%. On $100,000, that is a $1,000 difference each year!
The moral of course is that, with everything else equal, funds with lower expense ratios let you keep more of your money (an important caveat that many people forget – do not compare the expenses of apples and oranges!).
This on-going marketing cost is included in the expense ratio, but usually the fund company pays this to the broker or adviser who sold the fund to you. This fee often ranges between 0.25%-1% each year, so on a 0.25% 12b-1 fee an adviser would receive $250/year for having sold $100,000 of these mutual fund shares.
These commissions paid to a broker or adviser can vary on amount and timing, depending on the type (“share class”) of fund sold:
- “A” shares pay a commission when you purchase the fund, with the amount based on the particular fund bought and the dollar amount purchased. Just like when you go to Costco, there are price discounts (called “breakpoints”) when you buy shares in bulk! Many popular stock funds start around 5%, so in that case every $10,000 you invest pays the adviser $500 one-time.
- Less common “B” shares pay a commission if you sell the fund within a certain time period (usually years) but not when you purchase the fund. I do not see many of these sold these days, since the math to justify them rarely works out.
- “C” shares pay an on-going yearly commission to the adviser. You pay a higher on-going annual cost in exchange for keeping the entire purchase amount in your account.
- No-load shares are purchased directly from the mutual fund company without any compensation to an adviser. Do-it-yourself investors and advisers paid in other ways (like an annual fee) often use these shares.
- Do not view expenses as an evil to eliminate at all costs (pun intended). Purchasing the cheapest materials for your house or car may lead to other problems!
- In some situations, an adviser receiving commissions can provide you more value than you pay them in commissions; sometimes they cannot. Know which camp you fall in.
- Your individual situation dictates what type of mutual fund should fit your needs best.
In short, compare what value you receive compared to what you pay for that value!
If you need help finding this information out for your portfolio, contact me here and I will be happy to help!