The Minefield of Mutual Fund Fees

by James & Miel on August 4, 2009 · 0 comments

Hi All,

Mutual funds are a favored type of investment for Joe and Jane average. They have a number of advantages including professional management, exposure to diversification and the ability to efficiently tailor investing products to individual needs. However, one major drawback of mutual funds is fees.

There are several fees you might be obligated to pay, depending on the fund’s policies:

1) Front end loads. This is essentially a sales charge that goes to the brokers who sold you your shares. The fee is often based on the amount invested and is deducted from each investment. These generally decrease as the amount of the fund you buy increases.

2) Back end sales charges. Basically, this is a fee you pay to sell your shares. Generally the longer the shares are held, the more this charge declines. This fee usually goes to the broker who sells your shares.

3) You might get charged a straight purchase fee to buy shares. This yet another fee, but instead this one goes to the fund, not the broker. Similarly, if you want to unload your shares you’ll have to pay a fee to the fund called a redemption fee.

4) Some funds charge an exchange or transfer fee. For this one, if you try to transfer your shares out of your account, the broker will hit you with a transfer fee.

5) A lot of funds will hit you up with an annual account fee. This is just like an annual fee with a credit card, its simply a charge to maintain your account.

6) 12b-1 Fees: This is a charge for the costs of marketing and distribution. Since funds are business that often need to advertise, you can sometimes get stuck ponying up for the marketing and selling of the fund.

7) Other expenses. If annual account fees, loads, 12b-1 fees and transfer fees are not enough, you might get hit with a bill for custodial, accounting, transfer agent expenses or other administrative costs.

Fees should absolutely be minimized for two reasons.

First, fees depress return. The average mutual fund in the US charges about 1.4%. However, if you buy a fund with fees totalling even 1.4%, then your manager has to work that much harder to give you a return that makes up for the sales costs. Bottom line: fees depress your return and prohibit you from maximizing your wealth.

Second, fees create a conflict of interest. All things being equal, any sales person will attempt to push a product with a load on it. This is natural – sales people have to eat just like you and me and want to be compensated by selling you fee laden products. The problem with this is that fees rob you of the chance to get good objective advice because of this built in conflict of interest.

Just as an aside note, when my wife Miel and I were in Oregon a few years back, we got approached to buy a mutual fund with a 6% charge – nearly 4 times the average – at a Washington Mutual branch in Eugene. We fortunately declined that “opportunity”.

Best,

James

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