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Understanding Mutual Fund Fees

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mutual fund feesIf you think airline fees are confusing, wait till you try and understand mutual fund fees.

 
We are going to look at four mutual fund fees that you will encounter. 
 
These include: management fee, initial sales fee, deferred sales fee and redemption fee.

Sales Loads – Initial and Deferred

The initial and deferred sales fees make up what are referred to as loads.
 
This fee is a percentage the fund company charges you at the start or end of your investment with them. When they charge the fee at the beginning it is an initial sales fee.
If it is charged at the end when you sell your investment it is a deferred sales fee. 
 
Typically this fee is paid to an investment advisor as a commission.  It is taken out of your investment. 
 
If you are investing $1,000 and the initial sales fee is 5%, then $50 is subtracted for the fee and only $950 gets invested.
 
A deferred sales fee is also a percentage of your investment, but it is taken out when you withdrawal.  This one is not as straight forward as an initial fee, because there are many ways to calculate the fee. 
 
Some companies do it based on your initial amount, some do it based on the amount at withdrawal, and some actually reduce the fee over time
 
This reduction is known as a contingent deferred sales load or CDSC.  You will want to read the prospectus if you see how the fund calculates your deferred sales fee. 
 
These fees will change with your share class.  So if you like a fund but are not sure about the load see if they have a share class that does not have a load. This information will also be in the prospectus.

 

Redemption Fee

A redemption fee is similar to a deferred sales fee in that it is taken out when you redeem your shares.  The biggest difference is that it is kept by the fund company instead of being paid to your advisor.  This is a fee that they use to recoup costs associated with managing the account.
 
Many companies that have this fee waive after about 90 days.  They do this to get people to not trade in and out of mutual funds.  This is costly to the company. Not to mention detrimental to you and other investors. Check the prospectus to confirm you can waive the redemption fee after so many days.

 

Management Fees

Management fees are what the management company gets paid to make investment decisions.
 
These fees are one of the biggest impacts on your return over the years. The more you pay the management company, the more they have to beat the market. It reduces how much you get to reinvest and get the benefits of compounding.
 
This will not be taken directly out of your account, but rather those investment returns never get put into your account
 
They are paid from the assets of the funds before distributions are made.  Management fees can run from .08% to upwards of 5%, so there is a big difference that you should look for.

Impact of Mutual Fund Fees on Your Return

I want to show you exactly what the input of these fees are.
 
Lets look at an investment of $1,000. The return is $100 (10%). We will compare a a 1.5% fee versus a 1% fee.

Low fee – 1%

Year Invest Make Fee Net
1 1,000 100 1.00 99
2 1,099 109.9 1.10 108.80
3 1,207.80 120.78 1.21 119.57

High Fee – 1.5%

Year Invest Make Fee Net
1 1000 100 1.50 98.50
2 1098.50 109.85 1.65 108.20
3 1206.70 120.67 1.81 118.86

In an example found on the SEC’s website they calculated the long term version of the above and this is what they found:

“For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725. But if the fund had expenses of only 0.5%, then you would end up with $60,858.”

When looking at funds you don’t have to do your own calculations.  Fund Analyzer tool at the FINRA (The Financial Industry Regulatory Authority) website.

This allows you to enter the symbol of the funds you are considering and it will run a comparison on the fees for you.

As you are looking for funds to invest in pay close attention to the fees.  Fees can make or break your return on your money.  There are great funds for low fees available.   Don’t let fees eat away your returns.

Want more information on picking out mutual funds? Check out the Ultimate Guide to Choosing Mutual Funds.