1. What are mutual funds?

Portfolio Value From Investing $100,000 Over 20 Years

The chart below, published by the SEC, shows how a small difference in fees from one fund to another can add up to substantial differences in your investment returns over time:
Mutual Funds Growth Is Dependent on Fees

John Bogle, founder of the Vanguard Group, reported in his 2007 classic, “The Little Book of Common Sense Investing,” that over the 25 years between 1982 and 2007, the stock market index was providing an annual return of 12.3 percent while the average fund investor was earning only 7.3 percent a year after mutual fund expenses. That’s a big chunk of returns disappearing in fees!

Be Aware of Investment Fees

When considering an investment in mutual funds, keep the following in mind:

  • A fund with high costs must perform better than a low-cost fund to generate the same returns for you.
  • The more you pay in fees and expenses, the less money you will have in your investment portfolio to compound over time — and that can have a huge effect on the size of your retirement nest egg.
1. What are mutual funds?

Mutual Funds: Common Fees and Expenses

Common Fees

All of this convenience does not come cheap.

Like any business providing a service, running a mutual fund costs money, and like any other business, the costs are passed on to the consumer. That’s you, the investor.

Fees and expenses vary from fund to fund, and the amount you pay depends on the fund’s investment strategy and management. Most funds charge fees directly at the time of a transaction. Additionally, funds typically pay their regular and recurring fund-wide operating expenses out of fund assets instead of imposing these fees and charges directly on you.

Every mutual fund prospectus is required to disclose their fees, detailed as “Shareholder Fees” and/or “Annual Fund Operating Expenses.”

Typical “Shareholder Fees” include:

  • Sales loads — a commission to the broker who sells you the fund. The two general categories are a front-end sales load that you pay when you purchase the fund shares and a back-end or deferred sales load that you pay when you redeem (sell) your shares. FINRA does not permit mutual fund sales loads to exceed 8.5 percent.
  • Redemption fee — fee assessed when you sell shares (usually a percentage of the redemption price).
  • Exchange fee — some funds charge you when you transfer your shares to another fund, even if it’s within the same group of funds.
  • Account fee — a maintenance fee, typically placed on accounts below a specific value, $10,000 for example.
  • Purchase fee — different from the commission in the sales load, this purchase fee is paid to the fund, not the broker.

“Annual Fund Operating Expenses” include:

  • Management fees — fees paid out of fund assets for the fund’s investment advisor, managing the fund’s portfolio and administrative fees.
  • Distribution (12b-1) fees — fees paid for marketing and selling fund shares, advertising, printing and mailing prospectuses, etc. FINRA enforces a 0.75 percent cap on these fees.
  • Other expenses — this catch-all category includes shareholder service expenses, custodial fees, legal and accounting expenses, transfer agent expenses and other administrative costs.

Some funds identify themselves as “no-load” funds, which simply means they don’t charge any type of sales load. But no-load doesn’t mean no fees. A no-load fund will typically charge purchase fees, redemption fees, exchange fees and account fees.

Even minimal differences in fees between funds can add up to substantial differences in your investment returns over time. Just as the “magic of compounding interest” grows your portfolio over time, the “tyranny of compounding costs” takes a massive bite out of your potential gains over time.

The difference between an expense ratio of 0.15 percent and 1.5 percent might not seem like much, but the effect of the compounding over an investment’s lifetime is enormous. After 30 years, a fund with a 1.5 percent expense ratio could provide an investor with several hundred thousand dollars less for retirement than a 0.15 percent index fund with the same growth.

The important thing to remember is that all fees directly reduce your retirement portfolio growth. A fund with high costs must perform better than a low-cost fund to generate the same returns.

1. What are mutual funds?

Different Types of Mutual Funds

Mutual funds come in several different classes, and each class has its own fees and expenses. The most common mutual fund classes are A, B, and C for individual investors (like Betterment) and classes I and R for institutional investors.

1. Class A Mutual Funds

Class A fund shares usually charge a front-end sales load along with a small annual 12b-1 fee (12b-1 fees cover marketing and distributions costs, as well as investment adviser, transfer agent, custodian and administrator fees for a mutual fund.) They also require a larger initial investment than Class B or C funds.

Because of the up-front load requirement, Class A funds will offer discounts on the load based on the amount of the initial investment.

This is referred to as breakpoints, which you can think of as tiered pricing — the higher the investment that you make, the lower the upfront load will be.

In addition to the size of your initial investment, breakpoints will also factor into other mutual funds that you hold the same fund family, the frequency of your purchases, or even whether or not you have family members with an investment in the same fund family.

Because of the up-front fee, Class A fund shares are better suited for a long-term investment. This will allow you to recover the front-end load, in addition to the fact that 12b-1 fees are lower than what they are for other classes of funds.

2. Class B Mutual Funds

Class B funds are also load funds, except that the load is charged on the back end rather than the front. This load is sometimes referred to as a contingent or deferred-sales charge.

The load on Class B funds can be high; however, they typically decline over a space of several years. The longer you hold your fund position, the lower the load will be and usually disappearing entirely after six years.

The 12b-1 fees on Class B funds are higher than what they are on Class A funds, but once the back-end load fee provision disappears, the shares can be converted to Class A shares with their lower 12b-1 fees.

Because of the high back-end load on Class B shares, this class is best held for long-term investment, or at least until the load contingency disappears.

3. Class C Mutual Funds

Class C funds have high 12b-1 fees and may or may not have a front-end load, but if they do, it is much smaller than for Class A funds. Like Class B funds, they usually have a back-end load, which is typically only 1 percent.

The back-end load will usually disappear once you have held the fund for at least one year (but sometimes for as long as two years). Unlike Class B funds, Class C funds usually do not convert to Class A funds like way Class B funds will.

Because of the lower up-front load — if there is one at all — Class C mutual funds are usually better suited to shorter-term trading. This is especially true if the back-end load disappears after one year; you can hold onto the fund for one year, then sell without incurring any load charges.

4. Class I and Class R Mutual Funds

Class A, B, and C mutual funds are specifically for individual investors. Still, there are other classes, called Class I and Class R funds, that are set up primarily for institutional investing.

Class I funds are no-load funds that do not charge 12b-1 fees. They also have very high initial investment requirements because they are set up primarily for institutional purposes.

Class R funds are also no-load funds, but they do charge small 12b-1 fees. Class R funds are typically for retirement plans, such as 401(k), 403(b) and 457 plans.

The information, as to which share Class A mutual fund falls into, is available in the fund’s prospectus. But most of us ordinary folks are far more likely to segregate mutual funds into load versus no-load funds, or even front-load versus back-load.

1. What are mutual funds?

Who Are Mutual Funds Right For?

Mutual funds are convenient for investors who don’t have the time to spend researching their investment choices or aren’t interested in or feel qualified to manage their own investments.

Through a mutual fund, you can invest in a professionally managed, diversified portfolio of stocks without plunking down a huge amount of money. You are essentially buying fractional shares. Through a mutual fund you can own the stocks of hundreds of companies with just a small investment. And mutual funds offer the convenience of liquidity; it’s easy to get in and out of them.

1. What are mutual funds?

Mutual Funds: Convenient Investing for the Individual Investor

Investing in mutual funds is convenient, but is it worth the price?

Mutual Funds

Mutual funds are big business; there are more than 10,000 mutual funds available to individual investors, each with its investment objectives, fees, risks, and benefits.

It’s easy to understand why. Mutual funds pool together resources from thousands of investors and invest in a variety of different assets. That gives investors exposure to diversification for a fraction of the price if they invested in the assets themselves.

Diversification is essential to a well-balanced portfolio, especially during a time of stock market uncertainty.