Complete Guide to Mutual Fund Expenses

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Mutual Fund Education

Complete Guide to Mutual Fund Expenses

Mike Deane Jun 25, 2014

Mutual fund investing has been the cornerstone of long-term portfolios for decades, as investors have long used these products to construct diversified portfolios. But for all of the investing options that mutual funds provide, there can often be some confusion concerning their expenses and fees. Investing in a fund where you are unsure of the how the fee structure works can make for a nasty surprise when it comes time to pay up. Below, we outline the basic fee structure of mutual funds in an effort help investors make the best choice for their objectives.

Sales Loads

Front-End Loads

Front-end loads are imposed on the investor when they make a purchase of shares. It can be thought of as a commission fee, one that you would normally pay in your brokerage account when opening up a new position. The fee is usually percentage-based and will be taken away up front, lessening the amount of money you can invest in said asset.

For example, if you wanted to invest $1,000 in a fund with a 5% front-end load, $50 would be immediately paid (usually to a broker) while the remaining $950 is invested in the product. The SEC does not limit sales loads, but the Financial Industry Regulatory Authority (FINRA) caps them at 8.5%. This means that you will never pay a front-end fee in excess of 8.5% of your investment [see also 7 Questions to Ask When Buying a Mutual Fund].

Back-End Loads

Back-end loads (also known as deferred sales loads) are a bit trickier as there are a few attributes that go into calculating these fees. For a basic definition, back-end loads are fees that are paid when selling shares of a fund you already own. When it comes to calculating the fee, however, most funds only use your initial investment amount.

So, let’s say you invested $1,000 in a mutual fund that has a 5% back-end load. Now let’s assume that when you want to sell your shares, your position is worth $1,500. Most funds will apply the 5% back-end load to the lesser of your initial investment and the redemption value (the $1,000 in this example). In this case, your position would sell for $1,500 and you would pay a back-end load of $50 ($1,000 X 5%). If the position redemption value was at $900 (less than the initial investment), most funds would apply the back-end load to that value, charging $45.

There are some funds that will charge the fee based on the redemption value, but that is not commonplace. It is always a good idea to read through the prospectus to get a better idea of how fees are structured and exactly what you will pay when it comes time to buy and sell a certain fund.

Non-Load Fees

  • Redemption Fee: This is a fee charged when shares are redeemed, similar to a back-end load. Unlike deferred sales charges, however, redemption fees are paid directly to the fund, not the broker. The SEC limits redemption fees to 2%.
  • Exchange Fee: A fee charged if a shareholder transfers assets to another fund within the same group of mutual funds.
  • Account Fee: This fee is separate from any investments, and is instead charged for maintaining an account with a certain firm. Some may charge, for example, for accounts that have below a certain amount of funding.
  • Purchase Fee: Similar to a front-end sales load, purchase fees are paid up front when making an investment, but they instead go to the fund rather than a broker.
  • Management Fees: These are paid each year to the fund’s investment advisor from the fund’s assets to compensate for managing the fund’s portfolio.
  • Distribution/12b-1 Fees: Also paid out of the fund’s assets, these fees cover distribution expenses and shareholder service expenses. The “12b-1” term comes from an SEC rule of the same title that allows for these fees to be paid.

Why Fees Matter

The importance of fee management is best illustrated through a visual example. Let’s take a hypothetical position of $100,000 that earns a 5% return for 20 consecutive years. Now let’s take a look at how total annual operating expenses of a mutual fund can impact returns (note that these do not include fees associated with buying and selling the funds).

Not including expenses, that position will be worth $265,330 at the end of 20 years. But let’s see how that would change with funds that charge 1.5%, 1%, and 0.5% annually.

A look at how mutual fund expenses impact returns

To help you keep a better tab on your expenses and how they can impact you, FINRA offers a free tool to help you screen funds and understand the expenses that come with each investment.

The Bottom Line

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