Mutual Fund Fees
When you buy a mutual fund, you have to pay an up-front fee for the privilege of buying the fund, and you have to pay an ongoing fee for as long as you own the fund. You can find the estimate for a fund’s fees in the fee table near the front of the fund’s prospectus. You can use the fee table to compare the costs of different funds. The fee table breaks costs into two main categories: sales loads (paid when you buy, sell, or exchange your shares) and expense ratios (or yearly ongoing expenses).
A sales load is a term you will have to become familiar with if you intend to invest in mutual funds. A sales load charged by a mu-tual fund is used to pay commissions to the people who sell the fund’s shares to investors, as well as to pay for other marketing costs. Loads, which are usually given in percentage terms, can be as high as 6% of your investment. That is, if you invest $100 into buying a share of a mutual fund, $6 will be taken out to pay commission.
Some funds require you to pay the load when you buy shares of the fund. This is known as paying a front-end load. Others require that you pay when you sell your shares. This is known as paying a back-end load. Some funds charge no loads at all and these funds are known as no-load funds.
Of course, the bad thing about a front-end load is that it eats your money away immediately as soon as you invest in the fund. This may not be so bad if the value of your investment is going to sky-rocket. We recommend that Teenvestors stick only to funds that have no loads associated with them.
Regardless as to whether a fund has a load or not, funds charge investors each year primarily for managing the investments in the fund. Remember that in a mutual fund you leave the responsibility of determining what stocks to invest in to the people managing the fund. The fund manager makes buy and sell decisions for stocks in the fund and, of course, the manager is paid handsomely for his or her efforts each month.
The cost of running the fund also includes such things as basic as printing and postage expenses associated with the statements mailed to fund owners. Finally, funds also charge investors what’s known as 12b-1 fees—marketing and distribution fees. All of these costs are lumped into what is called the expense ratio—the percentage of the value of your investment that will go towards paying these costs for each year that the investor owns the fund.
Some investors mistakenly believe that if the expense ratios of their funds are high, it must mean that the managers of the funds are really good. The truth is that funds with high expense ratios do not typically perform better than funds with low expense. But there may be circumstances in which you decide it is appropriate for you to pay higher expenses.
For example, you can expect to pay higher expenses for certain types of funds that require extra work by its managers, such as international stock funds, which require more sophisticated research. You may also pay higher expenses for funds that provide special services, like toll-free telephone numbers, check-writing and automatic investment programs.
A difference in expenses that may look small to you can make a big difference in the value of your investment over time. In other words, the higher the expense ratio, the lower your return will be especially if you hang on to a mutual fund for a long time.
With regard to expense ratios, we recommend that, before you buy a mutual fund, you find out from the prospectus the estimates for the expenses that will be charged by the fund. The prospectus should lay all these expenses out in detail for you.