Are you thinking of investing in a mutual fund but are concerned about fees? Obviously, don’t pay for help in choosing a mutual fund if you don’t need it. If you do think you’ll need help or advice, you can choose from several choices of fee structures. This article will show you what to fees to look for when picking a mutual fund.
Load vs. No-load
Mutual funds fall into two broad categories: load and no-load. A “load” is a sales charge paid to a broker. Loads can be as high as 8 percent of the amount you invest, and typically fall between 4 and 6 percent.
“No-load” means there’s no sales charge. If you need professional advice to pick the right fund, you should buy a load fund. If you don’t need the advice, there are plenty of no-load funds from which to choose.
In addition, every mutual fund, whether load or no-load, charges annual fees, which are required to be shown as Expense Ratios in a prospectus, like these from Vanguard; or a fund fact sheet, like these from Nuveen. Unfortunately, funds with low or no sales load tend to have higher ongoing expense ratios, which means you have to look at both the sales load and the expense ratio of a fund in order to fully assess the cost.
The two biggest components of an Expense Ratio are:
– Investment management fees, which you pay to the professionals making the decisions about what securities, and when, to buy and sell.
– 12b-1 fees, which you pay for the fund to recoup its marketing, advertising, and distribution costs, but that, typically, are paid as additional compensation to your broker.
Choose a no-load fund if you don’t need advice
Because they’re the DIY version of mutual funds, no-load funds are generally less costly than load funds. This doesn’t mean there are no fees when you buy or sell shares. These funds don’t charge a “sales load” but they can still charge purchase fees, redemption (selling) fees, and account fees — essentially just horses of a different color. By regulation, funds that charge these other-named fees are allowed to mislabel themselves as “no-load” as long as certain other fees (in particular 12b-1 fees or shareholder service fees) don’t exceed 0.25 percent.
By the way, those 12b-1 fees are paid quarterly to a broker, whether it’s your specific broker or the brokerage firm where you have your account. If, for example, the 12b-1 fee is the usual 0.25 percent, and your fund shares are worth $2,000 on July 1st, the broker would get $1.25. If on October 1st, the shares are then worth $2,500, the broker would get another $1.50.
Choose a load fund, if you want investment advice
If you want the advice of a broker/financial advisor, you should choose a load fund. Load funds are offered in different versions, called “share classes.” The three common classes are A Shares, B Shares, and C Shares.
Different share classes produce different results. For example, the share class you choose determines how much, and when, your broker will be compensated.
– With A Shares, your broker is paid the sales charge up-front.
– With B Shares, s/he’s paid the sales charge when you sell the shares, at an amount that decreases annually until after the sixth year, when it disappears.
– With C Shares, s/he’s paid the sales charge only if you sell the shares within one year.
You choose a share class based on a balance between your investment goal and timeline. If your goal is have all your money working for you immediately, you should buy B Shares or C Shares over A Shares.
Here’s an example of what happens if you buy A Shares:
– You have $1,000 to invest.
– The load is 5.75 percent (the most common charge).
– Your broker will get $57.50.
– You will only invest $943.50.
Your timeline, however, may play a more important role because of the long-term costs. First, see the table below, so you can better understand the reasons why time is so important.
This example uses Fidelity mutual fund’s A Shares, B Shares, and C Shares, to see how the ongoing expenses differ:
|Share Class||Sales Load||Annual mgmt. fee||annual 12b-1fee||Expense Ratio|
|B||5% to 0%||0.41%||1.00%||1.60%|
|C||1% to 0%||0.41%||1.00%||1.60%|
When you plan to sell is important
If you plan to keep your fund shares for six or more years, consider buying A Shares. Over the long-term, paying lower annual expenses will save you more money than avoiding the sales charge.
B Shares may not be the best choice for either a short timeline or a long one. If you sell within six years, you’ll pay a sales charge, and you will also pay higher annual expenses than you would pay for A Shares. After six years, B Share expenses convert to be the same as the A Shares; but the total average annual cost to you will still be higher than for A Shares.
C Shares may be your best choice if you plan to sell the shares after one year but before six years. This is because the sales charge disappears after one year, so paying higher annual expenses for a few years may still be cheaper than the cost of buying A Shares. Beware though: C Shares will be the most expensive over the long-term, because, unlike B Shares, those high annual expenses don’t convert to be the same as A Shares. They stay high forever.
How to calculate what you pay in ongoing fees
The sales charge (the load) is a one-time charge and is simply a percentage of the amount you’re investing. Calculating the annual Expense Ratio isn’t quite so straightforward, although just as important to know.
You find the dollar amount of the Expense Ratio by calculating it as a percentage of the share price at the end of each quarter-year, then divide that number by four to get the dollar amount of the quarterly fee. For example, here’s what you would pay for one of Fidelity’s fund’s A Shares, B Shares, and C Shares at the end of two different quarters (you have to click on the “Fees & Distribution” tab to see the fees for each share class):
|Date||April 1||April 1||July 1||July 1|
|share class||A||B & C||A||B & C|
A final word about fees and expenses
If you want professional help choosing a mutual fund, don’t hesitate to choose a load fund. Just be careful to choose the right share class and the lowest expense ratio for your investment timeline. Failing to do this could cost you thousands of dollars in unnecessary expenses over the long-term.
Whether it’s a load or a no-load, any fund with high costs must perform better than a lower-cost fund to generate the same earnings for you. Even small differences in fees can translate into large differences in earnings over time. For example, if you invest $10,000 in a fund that averages a 10 percent annual return before expenses and the fund’s expenses average 1.5 percent a year, then after 20 years you would have about $50,000. But if the fund’s expenses average only 0.5 pecent, then you would have about $61,000. That’s a big difference based solely on the amount of fees.
If you’d like to analyze the impact of fees and expenses on your fund investments, and look up the fees for different funds, FINRA, the Financial Industry Regulatory Authority, has an excellent tool called the Fund Analyzer.