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| Investment Costs:
No Free Lunch |
| In life, nothing
is free. That's especially true when you're talking
about the world of investing. |
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| There are many costs associated with
saving for retirement. For instance, your employer
needs to foot the bill for setting up your retirement
plan, buying educational materials, and keeping
track of how much you've saved. |
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| On top of that, the funds you invest in have a number
of costs, including the management fee (paid to the fund's advisors for
managing the portfolio), administrative fees (which pay for the day-to-day
operations of the fund), front-end loads, back-end loads, and, for some
funds, 12b-1 fees (which cover a fund's distribution and advertising costs). |
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| Most of these fees are bundled up into what's known as
the expense ratio, which is deducted directly from your fund's return.
Any return a fund publishes, such as in a magazine or in its prospectus,
already has these costs taken out. So, if your fund earns 11% in a year,
but has a 1% expense ratio, you actually only make 10%. And that's the
figure the fund will print. |
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| Some mutual funds also sock you with a sales charge
(also known as loads). These come directly from your investments.
Unless otherwise stated, most published fund returns do not account
for any sales loads. (Morningstar, Inc., however, uses load-adjusted
returns for star-rating purposes). If you invest $1,000 in a fund with
a 5% sales charge, you actually only invest $950. While you won't
typically pay loads on the funds in a defined contribution retirement
plan, you might on funds you purchase for an IRA or a taxable account. |
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| Another charge that you might encounter as a fund shareholder is a transaction or redemption fee. The idea behind these fees 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. |
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| 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. And remember, a fund that is charging higher fees does not
necessarily mean it will be outperforming those funds that have lower fees
and vice versa. |
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