Fund Fee Primer

February 26, 2007

Front-end loads, back-end loads, expense ratios, management fees, redemption fees, 12b-1s. If you're confused by all the fees associated with mutual fund investing, you're not alone. But since the amount you pay to your mutual fund company can make a huge difference to your long-term returns, getting fee-wise is something all fund investors need to do. Doug Roberts at bloggingstocks makes you a little smarter with this brief intro.

There are two types of mutual fund fees and expenses -- the single shots and those that are ongoing. The single shots generally consist of one-time charges, like sales fees and redemption fees.

Sales fees or commissions, often referred to as a "sales load," may be charged when you enter the fund (front-end) and when you exit it (back-end). They are usually paid to the mutual fund company, the broker or salesman.

I strongly urge you to avoid investing in funds that charge a sales commission. When a sales commission is charged, possibly 4% to 5%, this means that you must outperform a similar fund without a commission by that amount just to match its performance. This is usually not an easy task. Furthermore, a sales load locks you into the fund. You need to stay in it for a long time to cover this cost and still get a competitive rate of return. When a commission is charged, you never know if your broker or advisor is favoring the fund that is best for you, or the one he stands to profit from the most. Often, if you do some detective work, you can find a similar fund without the commission, sometimes with the same manager.

Redemption fees usually refer to fees charged for early redemption in order to discourage short-term trading and "market timing." These fees are not bad for the long-term investor, as long as they are reinvested into the fund and not pocketed by the fund managers, brokers or salesmen.

With redemption fees, the key is to ensure that the fee is paid to the mutual fund itself. In general, I prefer funds that do not extend their redemption fees longer than three to six months, unless they offer superior performance for their category with a very low expense ratio.

In addition to these one-time charges, there are ongoing fees that are charged every year and impact the performance of the fund, even for the long-term investor. These include the expense ratio and brokerage costs.

The expense ratio is the total annual expenses of the fund, expressed as a percent of assets in the fund. It includes the management fee paid to the mutual fund manager, operating and administrative fees paid to run the fund, and 12b-1 fees used to market and distribute the fund. The general rule with expense ratios is "The lower the better." New funds sometimes have high expense ratios because of their small size. These funds should make every attempt to lower the expense ratio as they grow. This indicates a cost-conscious environment and a desire to put shareholders first."

Diligent fund investors need to look for (and avoid) level loads as well as front and back end loads. Level loads are 12b-1 fees in excess of 0.25% per year. Funds with such ongoing sales commissions will be categorized as "LOAD" on our website (red LOAD graphic) and will not come up in screens if you exclude load funds - even though these funds have no front or back end load


See also:

A Fund Fee We Love
The Worst Mutual Fund Investing Advice Ever
Are You Paying A Sales Load?