Mutual Fund Costs

With a majority of mutual funds, what you see is not what you get. This is on account of the costs associated with mutual funds, which are almost always out of sight at first glance. David F. Swensen, a financial wizard and Chief Investment Officer for the Yale University Endowment, which is currently worth $22.5 billion, has frequently expressed outrage at the high fees charged by mutual fund managers. It follows that a mutual fund investor should at least be aware of the costs, and be able to work out the actual performance of the fund, after the costs have been deducted from the returns.

The fees associated with mutual funds fall into two broad categories – Annual fees charged by the fund manager, and secondly the transaction fees that you may be charged when you buy or sell shares in a mutual fund, known as loads.

The annual fees, or as they are better known in terms of the expense ratio, is a percentage of the fund’s assets, ranging from 0.5% to 1%, and sometimes even as high as 2%. This may seem like a small figure when you look upon it as a percentage of your purchase, but when you look at the total assets the fund manages, ranging from a few hundred million to more than a few billion dollars, and then calculate the expense ratio, you can see that the total fee charged by the fund is overly exorbitant. These costs include everything that the manager spends and pays for, including office expenses, paperwork, fund marketing costs, salaries and utility costs. Even after factoring in additional massive amounts as advisory profits for the principals of the fund, the annual costs are still considered above average. And this is just the annual costs. The loads, if any, are separate from these costs.

Front end loads are a kind of commission the fund hands over to brokers or salespersons who convince you to invest in the fund. So when you invest a certain amount in a mutual fund with a front end load, a percentage of the investment will be deducted to pay a “sales fee”, and the balance will be invested. Back end loads are a period graded system for charging mutual fund investors selling off their funds. Back end loads are typically higher during the initial period after purchase, and decrease in a graded manner every year after purchase.

In summary, before you invest in a mutual fund, you need to make sure that the expense ratios are at or below market averages. It is to be noted that higher expense ratios and a well known fund manager do not necessarily perform better than other funds wit low expense ratios. Studies have repeatedly shown that there is very little connection between expense ratios and mutual fund performance. It is therefore advisable to seek out funds with low expense ratios, all other factors being the same. Secondly, avoid mutual funds with loads. Loads will eat into your investments and offer returns very much below par from industry averages. You are advised to consult your financial planner and understand mutual funds, the associated costs and relative benefits and risks when compared to direct stock investments in the market.