The investor faces a bewildering menu of fees when choosing a fund from the thousands available.
There`s no such thing as a free lunch or a free mutual fund. All mutual funds charge fees. After all, how else would they stay in business? Although there is no way to avoid paying fees, understanding how they work and what they are used for can make them a little more palatable. This article can help. But, to avoid surprises about fees, an investor should read about them in a fund`s prospectus.
Mutual fund fees come in many shapes and sizes:
Management fees-One of the benefits of mutual fund investing is the value received from professional portfolio management. All funds charge a fee, paid out of the fund`s earnings, to cover investment-management services, such as research and the advice of the portfolio manager.
Operating expenses-All funds have operating expenses such as overhead, legal fees, printing of the fund`s prospectuses and statements and processing fees. Moneys to cover these also are paid out of the fund`s earnings.
Sales charges-These are fees an investor pays for the added value of having a professional help choose the right funds for him or her. They cover the cost of items such as commissions and distributions to the public. For funds purchased directly from a mutual fund company, without the assistance of a financial adviser, charges may be imposed to cover marketing and advertising costs. Sales charges usually include one or a combination of the following:
- Front-end loads - also known as "A" shares, are sales charges deducted from the amount of your original investment.
- Deferred loads - also called contingent-deferred sales charges (CDSC) or "B" shares, are imposed if you sell fund shares before a specified period of time passes.
- Level loads - also known as "C" shares, typically do not charge anything up front, but you may incur a small CDSC if you sell "C" shares within one year or so of purchasing them. Level-load funds generally tend to have higher 12b-1 fees (explained below).
- 12b-1 fees - are named after a rule which allows mutual funds to deduct the cost of advertising and marketing directly from the fund`s assets. They typically range from 0.25 to 0.30 percent (but some can run as high as 1.25 percent) annually.
Choosing the Right Fund Front-end load funds are named as such because an investor is charged up front when shares are purchased. Charges generally range from 3 percent to 6 percent and are deducted from the initial investment. For example, if you invest $10,000 into a front-end load fund that charges 6 percent, your charge of $600 would be deducted from $10,000, making your net initial investment $9,400. Most funds offer breakpoints, which means when you reach a certain level of assets invested, the percentage of the fee decreases.
Front-load fund fees are easy to understand. They offer lower expenses, which can enhance investment returns over time when compared to other categories of mutual funds.
Conversely, back-end load funds do not charge an up-front sales charge. Rather, a fee is paid if the shares are redeemed within a specified time period, generally five or six years. The fee is based on a percentage of the shares` net asset value (NAV) at the time of redemption. The charges usually start around 4 percent to 6 percent and decline over time until they disappear. They also may be called contingent deferred sales charges (CDSC).
Over time, back-end charges may be more costly than front-end loads, due to higher expenses. However, with this type of fund, all your invested dollars go to work for you immediately. And, if you keep your money invested for the required amount of time, riding out the market ups and downs, you may be able to avoid sales charges altogether.
Level- or low-load shares usually do not have up-front sales charges, although an investor may be subject to a CDSC of around 1 percent if shares are redeemed prior to a specified period of time, usually around one year. For investors with uncertain investment-time horizons, however, the low CDSC may be worth the flexibility this type of fund provides. Over long periods of time, however, level-load fund shares can have the highest expenses, which may lower total return.
No-load funds, which do not charge a sales fee, usually are sold directly from fund families through advertising. Many investors believe, however, that the help they receive from an investment adviser is worth a sales charge. Some no-load funds may charge 12b-1 fees (defined above) and, as with all mutual funds, they all charge management and operational fees.
When shopping for mutual funds, be sure to select carefully the right type for your needs. Your investment adviser can help you make the appropriate decisions based on your investment goals, risk tolerance, the amount of money you have to invest and your time horizon. Be sure to read the fund`s prospectus carefully before investing.
The author is an investment executive with Advest, Inc., one of the country`s leading regional brokerage and investment firms. Her husband, Christopher, is a prosthodontist in private practice in Louisville, KY.