Mutual funds charge a variety of fees for purchasing, selling and holding a share. Some investors, especially new ones, may not understand how these fees work and how they can negatively impact returns on the investment. We looked at common mutual fund fees below and why investors should pay careful attention to them.
Understanding Common Mutual Fund Fees
Many mutual funds charge load fees, which are a sales or commission charge, usually 1-6% of the transaction, for either buying or selling a share. A sales charge when you purchase a mutual fund is called a front-end load. Front-end loads normally don’t exceed 6% of the total purchase. If you bought $100 of a mutual fund with a 5% front end load, you would pay $5 in commissions and only invest $95 in the fund. Mutual fund shares that have front-end loads are typically classified as Class A shares.
A back-end load is charged when you sell shares of a mutual fund and is commonly 5-6% of the transaction. Some mutual funds will reduce the back-end load each year that you hold the fund. For instance, a mutual fund might reduce a 6% back-end load by a percentage point each year you own the fund. Class B shares of mutual funds normally have back-end loads. A fund with a level-load has an annual charge, typically around 1%, applied for holding shares of the fund. Class C shares frequently have level-loads or no loads.
Mutual funds also charge an expense fee, which is an ongoing fee of the portfolio covering expenses of the fund company. It can be anywhere from 0.10% to 2.00% or more. This fee is taken from the value of the fund itself, so it doesn’t show up as a charge to investors. Mutual funds may also charge 12b-1 fees. 12b-1 fees are used to cover the cost of advertising the fund or creating the fund’s prospectus. A 12b-1 fee is limited to 1% of the portfolio, but not all mutual funds charge a 12b-1 fee. There are other fees that may be charged by mutual funds, such as redemption or exchange fees, but these are not as common as the three we listed above.
In addition to the fees charged by the mutual fund, most brokerages will also charge transaction or redemption fees for buying or selling a share of a mutual fund. Based on a comparison of 15 brokerages, the average cost to purchase a mutual fund was $30, so it’s smart to look for brokerages that offer no-transaction-fee (NTF) mutual funds.
Why You Should Pay Attention to Fees
Mutual funds that charge higher fees have not historically shown performance above funds with lower fees. Fees can eat into your returns and even principal funds, so it’s wise to minimize fees as much as possible. If you have the choice between two comparable mutual funds, but one has lower fees, it’s a normally good choice to pick the fund with lower fees.
We looked at three similar mutual funds with different fees to see how fees can negatively impact your returns. Fund 1 is a no-load fund with an expense ratio of 0.25%, Fund 2 is a no-load fund with an expense ratio of 1.25% and Fund 3 has a front-end load of 5% and an expense ratio of 1%. In our example, the investor invested $15,000 with no additional investments and earned 10% returns each year.
|Timeline||Fund A||Fund B||Fund C|
Fund 1, a no-load fund with a low expense fee, performed the best of the three funds. In fact, the investor lost out in over $16,000 of potential returns in the other two funds due to the high loads and fees. Because there are many no-load mutual funds with low expense fees and no 12b-1 fees, there’s almost no reason for an investor to pick a mutual fund that has higher fees over one that doesn’t.