| Mutual Fund Expenses continued... |
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| All of the expenses that we have mentioned so far can be thought of as coming out of the portfolio's raw return, skimmed off the top, so to speak. The total return numbers that you see on this web site already account for these costs: If a fund's return is 20%, that's its actual return to investors. If you had $100 invested in that fund, your investment would have grown to $120. As the table above shows, there are other expenses that are not already accounted for in a fund's return. Most of these are sales related. |
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| You Put the Load Right On Me Sales fees are often referred to as loads. Traditionally, loads were the compensation that brokers received for their advice. For example, if your broker advised you to make a $10,000 investment into a fund that had a 4.5% sales load, he or she would receive 4.5% of your investment, and the remaining $9,550 dollars would be invested into the fund. In some cases, though, loads go directly to the fund company. Many Fidelity offerings, for example, levy a 3% sales charge that is paid to Fidelity. Regardless of who the load goes to, it is taken out of your investment before it is invested in the fund. Back-end, or deferred, loads work in a similar fashion, except they are paid when you exit from a fund. Unless otherwise stated, most published fund returns do not account for any sales loads. (Morningstar, however, uses load-adjusted returns for star-rating purposes.) |
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| Another charge that you might encounter as a fund shareholder is a transaction or redemption fee. These fees are different from loads in that they are generally paid directly to the fund--they go back into the pot--rather than to the fund company. The idea behind them is that sudden inflows and outflows of cash force the fund manager to make purchases or sell securities, and imposing transaction fees fairly distributes the costs associated with such cash flows. Redemption fees are frequently used to discourage market timers or other active traders from moving in and out of the fund to the detriment of long-term shareholders. Although investors often resent these fees as an additional charge, if they weren't charged, the fund's net returns to shareholders would probably be lower. |
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| Finally, some fund companies charge account maintenance fees, usually for smaller accounts. If you own a Vanguard index fund, for example, you'll be charged a $10 account maintenance fee if your account balance is less than $10,000. On a small account, $10 a year can be fairly large on a percentage basis. |
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| Putting It All Together |
| So how should an investor compare fund costs? The expense ratio is probably the best place to start--while it doesn't include all of a fund's expenses, it does allow for meaningful fund-to-fund comparisons. From there, you'll want to consider any sales fees or redemption fees that a fund charges. Finally, take a look at brokerage costs. As a general rule, the higher a fund's turnover, the higher its brokerage costs (and the lower its tax efficiency). |
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| For example, Dreyfus Fund and USAA Growth & Income are both large-cap value funds, and both have reasonable expense ratios, 0.71% and 0.89% respectively. However, if you consider the brokerage costs of the funds, it turns out that Dreyfus Fund, with annual brokerage costs of 0.50% is a more expensive option than USAA Growth & Income, which incurs only 0.09% in brokerage costs. |
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