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Mutual Fund Fees
A mutual fund will classify expenses into either annual operating fees or shareholder fees. Annual fund operating fees are an annual percentage of the funds under management, usually ranging from 1-3%. Annual operating fees are collectively known as the expense ratio. A fund's expense ratio is the summation of the advisory or management fee and its administrative costs.
Shareholder fees, which come in the form of sales charges, commissions and redemption fees, are paid directly by investors when purchasing or selling the funds. Sales charges or commissions are known as "the load" of a mutual fund. When a mutual fund has a front-end load, fees are assessed when shares are purchased. For a back-end load, mutual fund fees are assessed when an investor sells his shares.
Sometimes, however, an investment company offers a no-load mutual fund, which doesn't carry any commission or sales charge. These funds are distributed directly by an investment company rather than through a secondary party.
Some funds also charge fees and penalties for early withdrawals or selling the holding before a specific time has elapsed. Also, the rise of exchange-traded funds, which have much lower fees thanks to their passive management structure, have been giving mutual funds considerable competition for investors' dollars. Articles in the financial media about how fund expense ratios and loads can eat into rates of return have also stirred negative feelings about mutual funds.
Classes of Mutual Fund Shares
Mutual fund shares come in several classes. Their differences reflect the number and size of fees associated with them.
Currently, most individual investors purchase mutual funds with A shares through a broker. This purchase includes a front-end load of up to 5% or more, plus management fees and ongoing fees for distributions, also known as 12b-1 fees. To top it off, loads on A shares vary quite a bit, which can create a conflict of interest. Financial advisors selling these products may encourage clients to buy higher-load offerings to bring in bigger commissions for themselves. With front-end funds, the investor pays these expenses as they buy into the fund.
To remedy these problems and meet fiduciary-rule standards investment companies have started designating new share classes, including "level load” C shares, which generally don’t have a front-end load but carry a 1% 12b-1 annual distribution fee.
Funds that charge management and other fees when an investor sell their holdings are classified as Class B shares.
A New Class of Shares
The newest share class, developed in 2016, consists of clean shares. Clean shares do not have front-end sales loads or annual 12b-1 fees for fund services. American Funds, Janus and MFS, are all fund companies currently offering clean shares.
By standardizing fees and loads, the new classes enhance transparency for mutual fund investors and, of course, save them money. For example, an investor who rolls $10,000 into an individual retirement account (IRA) with a clean-share fund could earn nearly $1,800 more over a 30-year period as compared to an average A-share fund, according to an April 2017 Morningstar report, co-written by Aron Szapiro, Morningstar director of policy research, and Paul Ellenbogen, head of global regulatory solutions.
Advantages of Mutual Funds
There are a variety of reasons that mutual funds have been the retail investor's vehicle of choice for decades. The overwhelming majority of money in employer-sponsored retirement plans goes into mutual funds.
Diversification
Diversification, or the mixing of investments and assets within a portfolio to reduce risk, is one of the advantages of investing in mutual funds. Buying individual company stocks and offsetting them with industrial sector stocks, for example, offers some diversification. However, a truly diversified portfolio has securities with different capitalizations and industries and bonds with varying maturities and issuers. Buying a mutual fund can achieve diversification cheaper and faster than by buying individual securities.
Easy Access
Trading on the major stock exchanges, mutual funds can be bought and sold with relative ease, making them highly liquid investments. Also, when it comes to certain types of assets, like foreign equities or exotic commodities, mutual funds are often the most feasible way—in fact, sometimes the only way—for individual investors to participate.
Economies of Scale
Mutual funds also provide economies of scale. Buying one spares the investor of the numerous commission charges needed to create a diversified portfolio. Buying only one security at a time leads to large transaction fees, which will eat up a good chunk of the investment. Also, the $100 to $200 an individual investor might be able to afford is usually not enough to buy a round lot of the stock, but it will purchase many mutual fund shares. The smaller denominations of mutual funds allow investors to take advantage of dollar cost averaging.
Professional Management
Most private, non-institutional money managers deal only with high-net-worth individuals—people with at least six figures to invest. However, mutual funds, as noted above, require much lower investment minimums. So, these funds provide a low-cost way for individual investors to experience and hopefully benefit from professional money management.
Freedom of Choice
Investors have the freedom to research and select from managers with a variety of styles and management goals. For instance, a fund manager may focus on value investing, growth investing, developed markets, emerging markets, income or macroeconomic investing, among many other styles. One manager may also oversee funds that employ several different styles.
Disadvantages of Mutual Funds
Liquidity, diversification, and professional management, all these factors make mutual funds attractive options for a younger, novice, and other individual investors who don't want to actively manage their money. However, no asset is perfect, and mutual funds have drawbacks too.
Fluctuating Returns
Like many other investments without a guaranteed return, there is always the possibility that the value of your mutual fund will depreciate. Equity mutual funds experience price fluctuations, along with the stocks that make up the fund. The Federal Deposit Insurance Corporation (FDIC) does not back up mutual fund investments, and there is no guarantee of performance with any fund. Of course, almost every investment carries risk. It is especially important for investors in money market funds to know that, unlike their bank counterparts, these will not be insured by the FDIC.
Heavy Cash Supplies
Mutual funds pool money from thousands of investors, so every day people are putting money into the fund as well as withdrawing it. To maintain the capacity to accommodate withdrawals funds typically have to keep a large portion of their portfolios in cash. Having ample cash is excellent for liquidity, but money is sitting around as cash and not working for you and thus is not very advantageous.
High Costs
Mutual funds provide investors with professional management, but it comes at a cost—those expense ratios mentioned earlier. These fees reduce the fund's overall payout, and they're assessed to mutual fund investors regardless of the performance of the fund. As you can imagine, in years when the fund doesn't make money, these fees only magnify losses.
Diworsification
Diworsification—a play on words—is an investment or portfolio strategy. Many mutual fund investors tend to overcomplicate matters. That is, they acquire too many funds that are highly related and, as a result, don't get the risk-reducing benefits of diversification. These investors may have made their portfolio more exposed; a syndrome called diworsification. At the other extreme, just because you own mutual funds doesn't mean you are automatically diversified. For example, a fund that invests only in a particular industry sector or region is still relatively risky.
Lack of Transparency
One thing that can lead to diworsification is the fact that a fund's purpose or makeup isn't always clear. Fund advertisements can guide investors down the wrong path. The Securities and Exchange Commission (SEC) requires that funds have at least 80% of assets in the particular type of investment implied in their names. How the remaining assets are invested is up to the fund manager. However, the different categories that qualify for the required 80% of the assets may be vague and wide-ranging. A fund can, therefore, manipulate prospective investors via its title. A fund that focuses narrowly on Congolese stocks, for example, could be sold with a far-ranging title "International High-Tech Fund."
Evaluating Funds
Researching and comparing funds can be difficult. Unlike stocks, mutual funds do not offer investors the opportunity to juxtapose the price to earnings (P/E) ratio, sales growth, earnings per share (EPS), or other important data. A mutual fund's net asset value can offer some basis for comparison, but given the diversity of portfolios, comparing the proverbial apples to apples can be difficult, even among funds with similar names or stated objectives. Only index funds tracking the same markets tend to be genuinely comparable.
Example of a Mutual Fund
One of the most famous mutual funds in the investment universe is Fidelity Investments' Magellan Fund (FMAGX). Established in 1963 the fund had an investment objective of capital appreciation via investment in common stocks. Fidelity founder Edward Johnson originally managed it. The fund's glory days were between 1977 and 1990 when Peter Lynch served as its portfolio manager. Under Lynch's tenure, Magellan regularly posted 29% annual returns, almost double that of the S&P 500. Both the fund and Lynch became household words.
Even after Lynch left, Fidelity's performance continued strong, and assets under management (AUM) grew to nearly $110 billion in 2000, making it the largest fund in the world. By 1997, the fund had become so large that Fidelity closed it to new investors, and would not reopen it until 2008.
As of April 2019, Fidelity Magellan has over US$16 billion in assets and is managed by Jeffrey Feingold since 2011. The fund's performance has pretty much tracked or slightly surpassed that of the S&P 500.
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Mutual Fund Fees
A mutual fund will classify expenses into either annual operating fees or shareholder fees. Annual fund operating fees are an annual percentage of the funds under management, usually ranging from 1-3%. Annual operating fees are collectively known as the expense ratio. A fund's expense ratio is the summation of the advisory or management fee and its administrative costs.
Shareholder fees, which come in the form of sales charges, commissions and redemption fees, are paid directly by investors when purchasing or selling the funds. Sales charges or commissions are known as "the load" of a mutual fund. When a mutual fund has a front-end load, fees are assessed when shares are purchased. For a back-end load, mutual fund fees are assessed when an investor sells his shares.
Sometimes, however, an investment company offers a no-load mutual fund, which doesn't carry any commission or sales charge. These funds are distributed directly by an investment company rather than through a secondary party.
Some funds also charge fees and penalties for early withdrawals or selling the holding before a specific time has elapsed. Also, the rise of exchange-traded funds, which have much lower fees thanks to their passive management structure, have been giving mutual funds considerable competition for investors' dollars. Articles in the financial media about how fund expense ratios and loads can eat into rates of return have also stirred negative feelings about mutual funds.
Classes of Mutual Fund Shares
Mutual fund shares come in several classes. Their differences reflect the number and size of fees associated with them.
Currently, most individual investors purchase mutual funds with A shares through a broker. This purchase includes a front-end load of up to 5% or more, plus management fees and ongoing fees for distributions, also known as 12b-1 fees. To top it off, loads on A shares vary quite a bit, which can create a conflict of interest. Financial advisors selling these products may encourage clients to buy higher-load offerings to bring in bigger commissions for themselves. With front-end funds, the investor pays these expenses as they buy into the fund.
To remedy these problems and meet fiduciary-rule standards investment companies have started designating new share classes, including "level load” C shares, which generally don’t have a front-end load but carry a 1% 12b-1 annual distribution fee.
Funds that charge management and other fees when an investor sell their holdings are classified as Class B shares.
A New Class of Shares
The newest share class, developed in 2016, consists of clean shares. Clean shares do not have front-end sales loads or annual 12b-1 fees for fund services. American Funds, Janus and MFS, are all fund companies currently offering clean shares.
By standardizing fees and loads, the new classes enhance transparency for mutual fund investors and, of course, save them money. For example, an investor who rolls $10,000 into an individual retirement account (IRA) with a clean-share fund could earn nearly $1,800 more over a 30-year period as compared to an average A-share fund, according to an April 2017 Morningstar report, co-written by Aron Szapiro, Morningstar director of policy research, and Paul Ellenbogen, head of global regulatory solutions.
Advantages of Mutual Funds
There are a variety of reasons that mutual funds have been the retail investor's vehicle of choice for decades. The overwhelming majority of money in employer-sponsored retirement plans goes into mutual funds.
Diversification
Diversification, or the mixing of investments and assets within a portfolio to reduce risk, is one of the advantages of investing in mutual funds. Buying individual company stocks and offsetting them with industrial sector stocks, for example, offers some diversification. However, a truly diversified portfolio has securities with different capitalizations and industries and bonds with varying maturities and issuers. Buying a mutual fund can achieve diversification cheaper and faster than by buying individual securities.
Easy Access
Trading on the major stock exchanges, mutual funds can be bought and sold with relative ease, making them highly liquid investments. Also, when it comes to certain types of assets, like foreign equities or exotic commodities, mutual funds are often the most feasible way—in fact, sometimes the only way—for individual investors to participate.
Economies of Scale
Mutual funds also provide economies of scale. Buying one spares the investor of the numerous commission charges needed to create a diversified portfolio. Buying only one security at a time leads to large transaction fees, which will eat up a good chunk of the investment. Also, the $100 to $200 an individual investor might be able to afford is usually not enough to buy a round lot of the stock, but it will purchase many mutual fund shares. The smaller denominations of mutual funds allow investors to take advantage of dollar cost averaging.
Professional Management
Most private, non-institutional money managers deal only with high-net-worth individuals—people with at least six figures to invest. However, mutual funds, as noted above, require much lower investment minimums. So, these funds provide a low-cost way for individual investors to experience and hopefully benefit from professional money management.
Freedom of Choice
Investors have the freedom to research and select from managers with a variety of styles and management goals. For instance, a fund manager may focus on value investing, growth investing, developed markets, emerging markets, income or macroeconomic investing, among many other styles. One manager may also oversee funds that employ several different styles.
Disadvantages of Mutual Funds
Liquidity, diversification, and professional management, all these factors make mutual funds attractive options for a younger, novice, and other individual investors who don't want to actively manage their money. However, no asset is perfect, and mutual funds have drawbacks too.
Fluctuating Returns
Like many other investments without a guaranteed return, there is always the possibility that the value of your mutual fund will depreciate. Equity mutual funds experience price fluctuations, along with the stocks that make up the fund. The Federal Deposit Insurance Corporation (FDIC) does not back up mutual fund investments, and there is no guarantee of performance with any fund. Of course, almost every investment carries risk. It is especially important for investors in money market funds to know that, unlike their bank counterparts, these will not be insured by the FDIC.
Heavy Cash Supplies
Mutual funds pool money from thousands of investors, so every day people are putting money into the fund as well as withdrawing it. To maintain the capacity to accommodate withdrawals funds typically have to keep a large portion of their portfolios in cash. Having ample cash is excellent for liquidity, but money is sitting around as cash and not working for you and thus is not very advantageous.
High Costs
Mutual funds provide investors with professional management, but it comes at a cost—those expense ratios mentioned earlier. These fees reduce the fund's overall payout, and they're assessed to mutual fund investors regardless of the performance of the fund. As you can imagine, in years when the fund doesn't make money, these fees only magnify losses.
Diworsification
Diworsification—a play on words—is an investment or portfolio strategy. Many mutual fund investors tend to overcomplicate matters. That is, they acquire too many funds that are highly related and, as a result, don't get the risk-reducing benefits of diversification. These investors may have made their portfolio more exposed; a syndrome called diworsification. At the other extreme, just because you own mutual funds doesn't mean you are automatically diversified. For example, a fund that invests only in a particular industry sector or region is still relatively risky.
Lack of Transparency
One thing that can lead to diworsification is the fact that a fund's purpose or makeup isn't always clear. Fund advertisements can guide investors down the wrong path. The Securities and Exchange Commission (SEC) requires that funds have at least 80% of assets in the particular type of investment implied in their names. How the remaining assets are invested is up to the fund manager. However, the different categories that qualify for the required 80% of the assets may be vague and wide-ranging. A fund can, therefore, manipulate prospective investors via its title. A fund that focuses narrowly on Congolese stocks, for example, could be sold with a far-ranging title "International High-Tech Fund."
Evaluating Funds
Researching and comparing funds can be difficult. Unlike stocks, mutual funds do not offer investors the opportunity to juxtapose the price to earnings (P/E) ratio, sales growth, earnings per share (EPS), or other important data. A mutual fund's net asset value can offer some basis for comparison, but given the diversity of portfolios, comparing the proverbial apples to apples can be difficult, even among funds with similar names or stated objectives. Only index funds tracking the same markets tend to be genuinely comparable.
Example of a Mutual Fund
One of the most famous mutual funds in the investment universe is Fidelity Investments' Magellan Fund (FMAGX). Established in 1963 the fund had an investment objective of capital appreciation via investment in common stocks. Fidelity founder Edward Johnson originally managed it. The fund's glory days were between 1977 and 1990 when Peter Lynch served as its portfolio manager. Under Lynch's tenure, Magellan regularly posted 29% annual returns, almost double that of the S&P 500. Both the fund and Lynch became household words.
Even after Lynch left, Fidelity's performance continued strong, and assets under management (AUM) grew to nearly $110 billion in 2000, making it the largest fund in the world. By 1997, the fund had become so large that Fidelity closed it to new investors, and would not reopen it until 2008.
As of April 2019, Fidelity Magellan has over US$16 billion in assets and is managed by Jeffrey Feingold since 2011. The fund's performance has pretty much tracked or slightly surpassed that of the S&P 500.
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