Understand the Costs of a Mutual Fund

Like many businesses, mutual fund companies have to pay the costs of operating. Many of the costs are passed to shareholders. Since these costs can have a significant impact on your investments and returns, understanding them now will prove to be financially beneficial in the long run.

Generally, there are two types of fees that you will incur when it comes to mutual funds.

The first type of fee revolves around the transactions of acquiring and selling shares of mutual funds. A fund company may impose a fee to purchase, sell or exchange mutual funds. This is often the case when you buy or sell shares of a mutual fund that is offered by another fund company. For example, if you have a Fidelity account, you’ll pay a fee to purchase a Vanguard mutual fund. There would be no fee to buy shares of a Fidelity fund.

Additionally, brokerages may impose a sales charge, or load. Mutual funds with front-end loads will deduct a small percentage of your investment. For instance, a 5 percent front-end load on a $1,000 investment would result in a $50 sales charge and $950 invested. A back-end load is a similar charge for selling fund shares -- this type of load may decrease the longer you hold the shares.

Because of the transactions costs involved, frequent buying and selling of mutual funds may not be wise.

The second type of fee covers the costs of operating the mutual fund on an annual basis. The fees go to the fund-management team and for marketing and/or other services. These fees make up the expense ratio -- a percentage of the fund’s assets.

Actively managed mutual funds tend to have high expense ratios while index funds have extremely low expense ratios.

The expense ratio has a major effect on the effective return of your investments over a long period of time. So, expense ratios will play a major factor in your choice of mutual funds.