$17Bn – $34Bn every year!
That’s what the White House Council of Economic Advisers (CEA) report stated investors pay in fees annually.
Mutual funds have always been notorious for their high fees.
The first mutual fund, as we know it today, was created in 1924. So mutual funds have been around for a while.
… And for decades, individual investors had no option to diversify their wealth but to invest in a mutual fund.
As the wealth of Americans grew, the number of mutual funds exploded and so did the amount investors paid in different type of fees.
Before we dig into the mutual fund fees, I want to tell you about the share classes of mutual funds and what they mean for the fees you pay.
Generally mutual funds have 3 different classes of shares: A, B and C. Each of these classes has different fees associated with it as the table below shows:
|Class A||Front-end Load|
|Class B||Back-end Load|
|Class C||Ongoing Fees (part of fund expenses)|
Let’s dig into these.
This is the one time fee you pay upfront in commissions to the broker from whom you purchase the fund.
For example, let’s take a look at the fund: GIGAX (Aberdeen International Equity A). As seen in the Morningstar summary:
GIGAX has a front end load of 5.75%.
Say you invest $10,000 in GIGAX through a broker, $575 is paid to the broker as commission (front-end load) and the rest, $9,425 gets invested in the fund.
You are basically paying the salesperson for being good enough to convince you to buy the fund. In case you have any doubt, this is a fee you should never, ever have to pay.
Back-end load is also known as contingent deferred sales charge (CDSC). The idea behind this type of commission is that it only applies if you sell your shares in the fund before the specified holding period.
Now, just because a fund is charging you a back-end load doesn’t mean you get a better deal compared to when you are charged a front-end load.
Basically, the fund sets the holding period based on the time it takes to recover the commissions the fund pays to the broker for selling you the fund.
Generally funds with back-end loads have higher 12b-1 fees compared to funds with front-end loads. We explain 12b-1 fees later on.
Let’s look at an example…
If you take a look at the fund ticker ABICX, Morningstar’s summary shows:
This load you see here is back-end load — meaning if you sell the fund before the holding period, you will have to forgo 1% of your assets to the fund.
Now, to determine the “holding period”, you can click the “Filings Tab”, and then click ‘Summary Prospectus”.
The summary prospectus for ABICX shows the details.
The prospectus shows the holding period of 1 year for C shares .
This means if you take your money out of the fund before the 1 year is up, you can only withdraw 99% of your assets.
The holding period is listed in disclosure for Class C shares.
You see how hard they make it for you to find this information? Again, there is absolutely no reason you should ever buy a fund with a back-end load
Annual Fund Expenses
If you want to find out the expenses for any fund, you can visit Morningstar, enter the ticker and out comes the fund summary where you will find the annual expenses.
The annual expenses are a combination of several fees.
If we continue with the previous example and look at the Morningstar summary for ABICX, you see the fund has annual expenses of 2.25%, definitely on the high side.
If you want to see the fee breakdown, you can click on the filing tab and see the fee breakdown for the 2.25% for class C shares.
This fee includes compensation of the portfolio manager and the research staff who select investments for the mutual fund. According to the summary prospectus, this fee is 0.75% of the amount you invest in the fund.
Distribution Fee (12b-1)
The prospectus shows that the annual distribution fee, also known as 12b-1 fee, is 1%.
12b-1 is the fee mutual funds pay on an ongoing basis to brokers for offering their fund to investors like you. Guess who pays for this? You guessed it right! You do!
As the prospectus shows this category includes transfer agent costs of 0.3% and other expenses of 0.2%.
Transfer agents are firms that act as record keepers for the mutual fund. They keep track of all the buying and selling the fund does and for that they need to be paid.
Other expenses include all other expenses the fund incurs such as legal, accounting, custody fees and other administrative expenses
How Should You Evaluate Mutual Fund Fees As An Investor?
These days, there is no reason to pay for mutual funds with loads. There are more than 22,000 mutual funds when you include all the different share classes.
Even if you are interested in investing in mutual funds, you can find no-load funds that charge 1% or less on an ongoing basis.
Since these fees are not flat fees but rather based on the assets you have invested, the dollar value of the fees adds up over time.
At YourCapital, our service shows how fees for your mutual funds increase over time.
This is what shows up for your fee analysis in YourCapital if you own ABICX in your portfolio.
As you can see, the increase in fees is non-linear. The more you pay in fees, the less your money compounds and grows over time.
While you should definitely pay attention to fund fees, fees alone should not be the only deciding factor.
You will have to look at the long term performance of the fund and evaluate if the fees are worth it.
While studies have shown that most fund managers don’t outperform their benchmarks once fees are taken into account, there are managers who “earn their keep” so to say by beating the benchmark.
The challenge -- finding such fund managers.
Let us know if you invest in mutual funds and focus on fund fees.
Mutual funds have a whole host of fees associated with them. Before you invest in any fund, check the various fees associated with the fund charges.
Nowadays, there are so many mutual funds to choose from, there is no reason to invest in load funds and you can find mutual funds that charge 1% or less on an ongoing basis.
Also something else for you to consider are products like index funds and exchange traded funds (ETFs) that mirror mutual fund benchmarks for an incredibly low fee.
Let me know if you consider fees when investing in a fund.