Fees & Loads

In addition to taxes, mutual fund fees also lower your investment returns. Before investing in a mutual fund, you should read its prospectus to understand all of the fund's fees.
A fund prospectus includes a table that shows how much in fees you pay to invest in the fund. You can download most prospectuses from the Web sites of most mutual fund companies.
There are two major categories of mutual fund fees: loads and operating expenses.
Loads are transaction fees that you pay when you buy or sell shares of a fund. The two main types of loads are front-end and back-end loads. Front-end loads are stated as a percentage of the investment amount. For example, if you invest in a fund that has a 3% front-end load, 3% of your investment is deducted and the remaining amount is used to buy shares of the fund. The maximum allowable front-end load is 8.5%.
Back-end loads are stated as a percentage of account value. Back-end loads are fees that you pay when you sell shares of a fund. Back-end loads are also called contingent deferred sales charges (CDSCs). Back-end loads usually decline a little each year over the first few years that you keep your shares.
A mutual fund often has several classes of fund shares. The class of shares indicates what fees you will pay to buy into the fund. For example, Class A shares charge a front-end load. Class B shares charge a back-end load. Whichever class of shares you buy, you buy shares of the same fund.
Other types of transaction fees that a fund may charge include early-redemption fees. Early-redemption fees are paid into the fund. A fund may also charge a fee if you maintain too low of a balance or transfer money between funds.
Operating expenses
The other major category of mutual fund fees is operating expenses. Operating expenses are deducted directly from the fund's assets and include:
Management fees.Management fees are paid to the investment adviser. The investment adviser is responsible for selecting the fund's holdings and earning a rate of return that meets or exceeds the fund's benchmark index. Management fees are often about 0.75% a year, or $75 on a $10,000 investment.
12(b)-1 fees. Mutual funds may charge up to 1% of the fund's assets as 12(b)-1 fees. These fees pay for the mutual fund's marketing expenses.
Administrative fees.Administrative fees pay for the recordkeeping and maintenance of fund ownership records: Who owns what shares and how many, for example.
The sum of these categories of operating fees is called the fund's operating expense ratio. Operating expense ratio is stated as a percentage of the fund's assets under management.
Operating expense ratios for most actively managed funds range between 1.25% and 2.25% of a fund's assets, or $125 to $225 a year on a $10,000 investment. Since an index fund is passively managed, its operating expense ratio is lower, often in the range of 0.25% and 0.75% of assets.
Operating expense ratio helps you compare the cost structure of similar mutual funds.
Impact of fees on returns
A mutual fund provides a summary table in its prospectus of how much you should expect to pay each year in loads and operating expenses.
For example, assume you invested $10,000 in a mutual fund a year ago. You paid a 2% front-end load and the fund's operating expense ratio was 1.5%. The value of the fund's portfolio increases 10% in the first year that you own shares.
Since the fund took $200 upfront in transaction fees, your net initial investment was $9,800. A year later, your initial investment is actually worth $10,780, for a one-year rate of return of 7.8%.
Next, deduct the 1.5% in operating expenses using the midpoint value of your shares during the year: $9,800 plus $10,780 divided by 2, or $10,290. Multiply that amount by 1.5% to get $154.
If you subtract $154 in operating fees from the value of your fund shares, your after-fee return is $10,626, for a one-year rate of return of 6.26%. As this example shows, loads and fees of owning a mutual fund can take a substantial chunk from their investment returns.
Mutual funds are required to show their investment returns after deducting fees and loads. Mutual funds are also required to show in their prospectuses fund returns net of income taxes based on the highest marginal individual income tax rate.
2008-07-21 14:38:07
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