Mutual Fund Expenses and Fees Critically Affect Profits

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Fees and Expenses are the biggest costs an investor can control.  Please pay attention to them.

When the average investor buys $10,000 of Class A shares in a load mutual fund, how much of that money actually goes into the market?

If you thought it would be $10,000, you are not even close.

By the time the average investor puts down $10,000 and leaves the investment adviser’s office, the way load mutual funds operate will mean only $9,450 will be invested in the market. The other $550 gets eaten up by sales charges, which go to the selling broker-dealer and the fund distributor. In addition, another $50 typically is paid as an underwriting commission to the fund distributor.

That’s just for starters. Every year, the shareholder pays about 25 basis points (bps), or one-quarter of 1%, in 12b-1 fees, a management fee of about 90 bps, plus a $20 administrative fee to the fund distributor.

Many mutual funds are so laden with fees that the U.S. Department of Labor has identified 17 fees that can be charged to shareholders. While some costs are well-known (administrative fees, for example), there are hidden costs, such as trading expenses, which add up to 50% to shareholders’ costs. Finance professor Burton Malkiel estimates that fees of just 3% over time can devour up to 50% of an investor’s investment returns.

Key Things to Remember
The critical thing for shareholders to remember is that the 12b-1 fees are charged annually to shareholders by the fund distributor to primarily pay for the mutual fund company’s sales and marketing efforts.

The original stated goal of 12b-1 fees, presented to regulators in the mid-1970s, was to increase shareholder communications and boost fund assets, which, in turn, would lower fund expenses. That was the idealized version.

But today, most fund companies, especially load companies, charge the 12b-1 fees to subsidize sales and marketing efforts yet rarely reduce shareholder expenses.

While this may seem complicated, the bottom line is that 12b-1 fees contribute to a fund’s total expense ratio. However, the arithmetic of mutual funds shows that the higher the expense ratio, the lower an investor’s return.

As fund returns become more volatile and erratic, one of the few things investors can control is costs.  You have to choose funds with low expenses.

ETFs have become more popular than mutual funds because they have more specific focuses and very low costs. Investment professionals do not recommend them because ETFs do not pay revenue sharing to advisors. Despite this, ETFs have become the instrument of choice for more knowledgeable investors who want to build their own portfolios.

However, the bottom line is that costs, especially over time, can deliver significantly more money into a shareholder’s account.  It is also the only investment variable an individual can control.

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Chuck Epstein has managed marketing communications and public relations departments for major global financial institutions and participated in the launch of industry-changing financial products. He also has written by-lined articles for over 50 publications, five books and served as editor and publisher of nation’s first newsletter on the topic of using the PC for personal investing and trading. (“Investing Online, 1994-1999). He also is a marketing consultant, writer and speaker on topics related to investor protection and opportunities in the very dynamic cannabis industry. He has held senior-level marketing, PR and communications positions at the New York Futures Exchange, Chicago Mercantile Exchange, Lind-Waldock, Zacks Investment Research, Russell Investments and Principal Financial. He has won national awards from the Mutual Fund Education Alliance (MFEA) and his web site, www.mutualfundreform.com, was named best small blog in 2009 by the Society of American Business Editors and Writers (SABEW).