Mutual funds incur costs that must be paid from fund assets. These costs are incurred through marketing, advisory fees, accountants’ fees, legal fees, custodial fees, etc. Simple transactions such as buying, selling and exchanging shares can be costly for mutual fund companies as well. The investor is the one who inevitably pays for these costs.
Fees imposed on the “transaction” are charged directly to the investor as a “load,” while operating expenses are paid from the fund assets. Therefore, ultimately the various costs a mutual fund investor incurs come either directly or indirectly from the investor’s pocket.
Listed below are the most common fees associated with mutual funds. These are in no particular order and can be costs of transactions, or fees charged to make up for normal operating expenses.
Sales Charge (Load):
This is a fee charged to compensate brokers the fund uses to sell its shares. There are two types of loads, front-end and back-end:
Front-End Load: This is a sales charge that is applied at the time of an initial purchase. This charge reduces the amount that is available to purchase shares. A front-end load is paid completely at the time shares are purchased.
Back-End Load: This is a sales charge that is applied when fund shares are redeemed. This is also known as a deferred sales charge. When purchasing a back-end loaded fund, all of the initial investment is used to purchase fund shares. These back-end loads are calculated one of two ways. In some funds, the back-end load is based on the lesser of the initial purchase, or the value of the investment at the time of redemption. In other cases, the load is referred to as a contingent deferred sales load, in which case the fee usually decreases each year the investor retains the shares, and is eventually eliminated.
A fee assessed to shareholders for some of a fund’s promotional (marketing and distribution) expenses.
A fee that some mutual fund companies charge to help maintain shareholder accounts.
A fee charged by some mutual fund companies when a shareholder transfers from one fund to another within the same family of funds.
A fee that is paid from fund assets to the investment adviser for management of the fund.
A fee charged when shares of a fund are purchased. This is not the same as front-end sales load, because the fee goes to the fund, not the broker.
A fee charged when a shareholder sells shares in a short period of time. The time limit varies among funds. Some funds charge a percentage, and some charge a flat dollar amount. The SEC generally limits this fee.
A note regarding “no-load” mutual funds—these funds are sometimes referred to as “free” funds, since there are no loads associated with them. However, just because a fund is a no-load fund does not mean that it is free. No-load simply means that there are no sales charges or loads as described above under Sales Charges (Loads). In reality, no-load mutual funds are permitted to charge fees such as redemption, exchange, account, and purchase fees. A fund can call itself a no-load fund as long as its 12b-1 fee and/or shareholder fees do not exceed a certain percentage of the fund’s average annual net assets.
As discussed earlier, when mutual fund shares are purchased through a broker, a sales charge is usually assessed. This charge is paid differently based on the class of shares purchased. Below are the three main types of mutual share classifications.
Class A Shares: Generally, expenses are lower on this share type than on B and C shares. Class A shares typically charge a front-end load, annual expenses, and usually include a 12b-1 fee. Because these shares are said to be the cheaper shares, investors who are in the market for the long-term usually prefer these shares.
Class B Shares: Expenses on these shares usually consist of a back-end load, and annual expenses. The back-end charges usually decrease the longer the shares are held, but typically, the annual expenses are greater on B shares than on A shares. If an investor holds B shares long enough for the back-end load to be eliminated, the shares will convert to A shares, so the lower expenses of A shares take effect.
Class C Shares: These shares do not charge loads, but typically have higher expenses than A shares. These shares do not convert to A shares. Therefore, if an investor has a long-term time horizon, it is typically not a good idea to invest in these shares, as higher expenses will probably be incurred. These shares are more appropriate for an investor who has a short time horizon for holding the shares.
At Henssler Financial, our investment philosophy states that if you have less than $50,000 to invest, mutual funds are a more viable option to help you formulate a well-diversified portfolio. We generally avoid load funds, as in most cases no-load funds are available to provide the investor with a similar investment mix without sales charges.
It is important that an investor consider all fees and charges when purchasing a mutual fund. Some no-load funds have a considerably higher expense ratio than others. Small Cap, Mid-Cap and international stock funds usually have higher expense ratios than Large Cap stock funds, as research on the companies in which these funds normally invest is more difficult to find and evaluate. Remember that all funds, even money market funds, have expenses associated with them.
Morningstar (either a printed version or on the web) is a valuable source of information on the various fees, expenses and sales charges associated with different mutual funds. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or [email protected].