Costs of Owning a Mutual Fund

If you decide to invest in mutual funds, it is inevitable you will incur costs and fees. Not all the costs are required, but many are necessary if you decide to invest in particular funds. Let's take a look at the various costs associated with owning mutual funds.

Load fees. Load fees are arguably the most common cost investors encounter when they decide to invest in mutual funds. What exactly is a load fee? It's actually a sales charge that you pay to whomever you purchase the fund from, such as a financial advisor or a broker. This fee is charged at the time you buy into a load fund or buy what is known in the world of mutual funds as Class A shares in a mutual fund.

Example Betty Bigbucks invests $20,000 in a corporate bond mutual fund she purchases from a mutual fund salesman, Sam Sellsshares. The fund is a load fund, so Sam takes a 5 percent commission charge from Betty's $20,000 ($1,000) and invests the remaining $19,000 for Betty into the mutual fund she chose.

Load fees do not please most investors. It feels like you start off with a loss right off the bat because you're investing less than you originally had. Do you have to pay load fees? No, because there are funds that are no-load funds, meaning they do not charge load fees when you purchase the shares in a mutual fund. With no-load funds, you buy shares directly from a mutual fund company, eliminating the middleperson.

Does this mean you should only look for no-load funds when picking a mutual fund? Why should you pay a sales charge to invest in mutual funds if you don't have to? There are a few reasons that you should take into consideration.

First and foremost, the most important reason to choose any fund is performance. Even if you have to pay a portion of the amount you're investing upfront for a load fund, if it performs better than a similar no-load fund, it is the better investment. Because mutual funds are traditionally investments for the long-term, your focus as an investor should be there as well.

The second most important reason to choose a load fund is service. If you invest in a mutual fund directly from a mutual fund company, you will not receive the personalized service you get from a broker or financial advisor. You obtain a prospectus and application from a company or a bank, return the application with your investment and you're done. If you need further information or anything else, you'll be at the mercy of the pool of customer service representatives that have no relationship with you and you'll probably never deal with the same person more than once.

Whether this is a disadvantage is a matter of personal preference. You may feel perfectly comfortable being left basically on your own to decide when and what to buy, transfer or sell. Another investor may like to have a financial professional who knows his or her personal situation and is involved in investing decisions having to do with the fund.

Lastly, another important factor to consider is that just because a fund is a no-load fund doesn't mean you won't be paying any sales charges. No load funds (like load funds) charge annual management fees that you must pay.

Management fees. Management fees are fees that mutual fund investors pay for management services (for example, salaries and expenses) of a fund. Management fees range from less than .5 to 3 percent of the value of an investor's fund. Generally, they are automatically deducted from your fund annually.

Did You Know? Management fees are required, but they do vary from fund to fund. Obviously, the deductions for these fees affect the return on your mutual fund investment. Therefore, you will want to be aware of the management fees your mutual funds charge and keep on top of any changes. You may discover that investing in or transferring to a similar fund with lower fees is a financially sound step if the fees are high.

Back-end load fees. Mutual funds that are back-end load funds (or Class B mutual funds) charge a load fee if you sell your shares in a mutual fund within a specific time period, which is usually anywhere from four to six years. The fee amount you pay is a percentage that declines each year you don't sell until you have been invested for the required time period.

Back-end load fees are another variation of traditional load fees. If you don't pay load fees upfront and you aren't invested in a fund long enough for a fund to recoup the commissions and expenses it has paid on your account through management fees and the like, the fund can collect from you when you sell.

Are back-end funds a bad investment idea? Generally, yes. Unless you are absolutely certain you will stay invested in a fund for a specific time period, and you want to invest in a particular fund, you are better off paying the load fees when you purchase the shares. This is true because back-end load fees are almost always a higher percentage of your investment than front-load fees and they carry higher expenses as well.

Did You Know? If you do purchase back-end load funds, also called Class B funds, you should check to see if they convert to Class A status (front-load funds) after a certain time period. Class A funds carry lower expense fees than Class B funds.

Redemption charges. Redemption charges are a version of back-end load fees. Funds can charge this fee whenever you redeem your shares, but most funds only charge this fee (a percentage of your investment) if you redeem your shares within a specific, short time period. You can find out whether a fund charges this fee by checking the fund's prospectus.

Marketing fee. Many funds charge an annual marketing fee (also known as a 12b-1 fee, named after a federal securities rule) of generally anywhere from 0.25 to 1 percent of assets managed. This fee is charged to cover the cost of marketing, advertising and sales. No-load funds are particularly likely to charge a marketing fee (although it must be below a certain percentage in order for the fund to be labeled no-load) to make up for not charging load fees.

Unless you simply must invest in a particular fund that imposes marketing fees, all other things being equal you should avoid these funds because they cost you a piece of your investment return on an annual basis.

Transaction fees. A sort of catch-all category, these are the fees that funds impose for postage, administering index funds, the paperwork involved with retirement accounts, dividend reinvestment and transfers from one fund to another in the same fund family. The amounts and percentages charged vary from fund to fund, as do the types of services they perform. You will want to inquire upfront about these fees before you invest in a fund because, depending on your personal situation, they can really add up.

Financial advisor fees. If you choose to invest in mutual funds without paying load charges, but consult a financial advisor for assistance with your investments, you should factor in the cost of your investment advice when determining the return on your mutual fund investment. You may find that going with load funds may actually be cheaper in the long run.

Planning Note It's important to keep in mind that independent financial advice can be invaluable in terms of creating a diversified investment portfolio based on your age and state of life. While no one is completely impartial, paying an advisor who is not connected with a brokerage house or mutual fund company, and who is not earning a commission based on the funds he or she sells, makes it more likely that you will be directed toward the investments right for meeting your investment goals.

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