The Mutual Fund Fees You Need To Know Before Investing

Mutual funds are a popular investment vehicle. They offer investors a simplified approach to diversification by giving them access to a wealth of diversified stocks and other securities through a mutual fund share(s). As opposed to purchasing individual stocks and securities, a mutual fund is an amalgamation of diversified asset classes managed by a professional financial company. 

While popular, mutual funds have received their fair share of critique from investors and money managers alike who experience sometimes exorbitant fees. Every investment will cost you something, but mutual funds have a complex array of fees that when not chosen carefully can have a significant impact on your overall returns. 

Today, we wanted to bring you a post that provides an overview of the fees you should be aware of before investing in mutual funds. Keep in mind that this is an overview and for detailed advice based on your situation, set up a time to talk with us.

It’s all about the load

Before investing in a mutual fund, it is important to understand the fees that will be taken out of your investments as it will have a significant impact on your total net return. One of those fees is a load. 

A load is a set of fees taken out of your investments that go toward paying commissions for those managing the fund like an advisor or broker. 

When we talk about fees for mutual funds, most are taken as a percentage of either your investment or overall return as opposed to being out-of-pocket. Think about it as a portion of what you buy and sell over the course of the fund. 

Mutual fund loads are not created equal. There are several types of loads that each impact your returns in different ways. Let’s take a closer look.

• Front-load. A front-load requires payment at the point of purchasing a fund. This load takes a percentage of the investment upfront. If, for example, you invest $2,000 with a 4% front load, the load totals $80 which brings your initial investment down from $2,000 to $1,920.
• Back-load. A back-load is the opposite of a front-load and takes a percentage when you sell the fund.
• Level load. This type of load doesn’t take a percentage at either the purchase or sale, rather the fees are taken out of the fund on a regularly scheduled basis. Most level load fees fall at about 1%. 
• No load. Some brokers won’t charge a load fee which is excellent news for your potential returns. 

Most front-load and back-load fees are around 5% and can be as high as 8.5%. Let’s look at an example. If you invest $10,000 in a mutual fund with a 7% front-load, the load total would be $700. This then leaves you with a starting investment of $9,300. 

Knowing how load fees operate in your mutual fund can help you make smarter investment choices, ones that will help you reach your goals. How will you know the type of load your mutual fund uses? You will need to look for the type of fund class you purchase. 

Fund classes

There are a few types of fund classes available. The type you choose often reflects the kind of load you can expect. Below is a breakdown of the classes and the loads they represent. 

• A: front-load
• B: back-load
• C: constant/level load

Understanding Expense Ratios 

Expense ratios are fees that cover the operating costs of running the mutual fund including management and operation fees. These fees keep the lights on, so to speak. As with load fees, expense ratios aren’t billed directly to the investor, rather they are taken from the investments themselves. Expense ratios deduct from your earnings in order to cover expenses.

Expense ratios vary significantly depending on the mutual fund. The fees can range anywhere from 0-5%. As with all fees, the lower the fee the better it will be for your investments. As you wade through mutual fund providers be on the lookout for those lower fees because they are out there. Remember, since these fees come directly from your earnings, the lower the fee the better the return.

Expense ratios will vary depending on the type of category your fund falls under. For example, large-cap stock funds may have a different expense ratio than foreign stock funds or bond funds would. Be sure you understand how the expense ratio functions before investing.

It is also important to know that actively managed funds are often more expensive than passively managed or index funds and often don’t perform better than their less expensive counterparts. 

Transaction fees can really cost you

Transaction costs are charges that occur when your investment professional buys and sells assets within the mutual fund. These are the costs of trading securities within the fund and they can add up quite quickly. Although they are often one-time charges, they are done each and every time the manager buys or sells a share, which can significantly cut into your net return. 

What are 12b-1 fees?

12b-1 fees are another lesser-known fee in mutual funds used for marketing. This fee is used to promote the mutual fund and is a commission-based fee that can climb upwards of 1%. This fee, like the others, is deducted from your overall return. 

Redemption fees

Yes, believe it or not, there are more fees to understand. Redemption fees are charged to investors when they sell a share. 

The fee for selling depends on how long you have held the share. Each fund has its own scale and percentage but the redemption period can be anywhere from 30 days to 1 year or more. Be sure that you know what those costs are and what percentage of your earnings would be eaten up in fees. 

It is important to note that redemption fees can’t exceed 2% as designed by the SEC.

Mutual funds aren’t all that tax-efficient 

On top of the laundry list of fees associated with running and maintaining a mutual fund, many advisors don’t find them to be very tax-efficient investments. Alongside the steep fees, funds that are actively managed often trigger more tax due to the more regular buying, selling, and trading of assets including capital gains tax (short and long term), and income tax from dividends and interest.

Exchange-traded funds (ETFs), on the other hand, are often more tax-efficient. ETFs are also more transparent and have higher liquidity.  

Talk with your advisor

As an investor, it is important that you are able to create an investment strategy tailored to your goals, risk tolerance, and investment timeline. In order to make the most of your investment, you will need to keep your costs as low as possible.

Mutual funds are littered with fees, many of which the lay investor doesn’t understand or see coming. Our advice? Before investing in a mutual fund, do your homework. All mutual funds have a prospectus available. Read it carefully. This document contains information regarding all of the fees that you can expect to incur when using that particular vehicle. 

Here at Legacy Wealth, we want to help you build your wealth in a low-cost, tax-efficient manner. There are many avenues to do that and we would love to speak with you and learn more about how we can help you reach your investment goals. Schedule a 15-minute call with us today.