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.