“How Much? What a Load of…”

Understanding What You Pay for Mutual Funds

By Anthony Rhodes

Of all the products available within our investment toolbox, none are more popular than mutual funds. They exist in our 401(k)’s, 403(b)’s, 457 Plans and others, and upon our retirement, are predominant in the majority of our IRA’s, as well. The reasons for this widespread use is based on practicality; as mutual funds allow investors to own multiple types of companies collectively, and at a very affordable price. In fact, if one were to purchase stocks of all the businesses held within their mutual funds, he or she would have to spend a small fortune in which to do so, and for this reason, are more likely to select this option when determining which investment tools to use.

Although these products are a cost effective alternative to individual stock purchases, this doesn’t necessarily qualify them as being cheap. The truth of the matter is that many mutual fund prices trade similarly to even high priced stocks, and when you add that in most cases, not all of your invested capital goes towards actual ownership, makes them even more expensive. This week, we’re going to dig into the actual expenditures which are associated with your mutual fund purchases. We’ll also seek to offer some alternatives to some of the more popular mutual fund choices, but at a fraction of the cost.  

Carrying the Load...or Not

We can’t delve into a discussion about mutual fund fees without first describing the relationship which exists between some mutual fund companies, brokerage firms and others. To make a long story short, these companies pay out a percentage of their fund purchases to these businesses, in order to attract their clients to their funds. This is called a “sales load” or “load”. Whenever you purchase a mutual fund, the odds are that a percentage of that payment will go towards such businesses under this arrangement. Now the percentage of this ‘load’ varies, and is generally categorized within what are called A Shares, B Shares, and C Shares. When you purchase A Share mutual funds, the percentage of the ‘load’ which is paid out to the business, comes out in the front end. This means that whatever that percentage turns out to be, it is paid out immediately after your mutual fund purchase. When you purchase B Share mutual funds, the ‘load’ comes out at the back end; meaning that the agreed upon percentage will be paid when you sell your mutual fund. And when you purchase C Share mutual funds, the ‘load’ is spread out over a certain amount of time. In addition to these ‘loads’, investors also payout a number of other fees (which are all explained in its prospectus) when they purchase mutual funds. There are management fees, 12b-1 fees, custodial fees and others, all of which contributes to your overall mutual fund costs, and decreases the overall value of your portfolio. However, it’s important to note that not all mutual funds come with sales loads. In fact, many fee-based investment advisors (myself included) choose to use “no-load” funds within our clients’ portfolios, in efforts to maximize their gains, and decrease their overall costs. Now this doesn’t mean that there aren’t other fees associated with buying no-load funds (i.e. redemption, reinvestment or exchange fees), but that such costs are charged by the fund itself, and not by those of us managing your portfolio.

Given 'em The Finger

 Another low cost alternative to consider are index funds. These tools track the performance of various indexes (the S&P 500, Dow Jones Industrial Average, etc.), and since they are non-managed, may not be as cost heavy as other mutual funds are. I say ‘may not’ because unfortunately, not all index funds are created equal, even though they all perform the very same function of tracking the exact same indexes. While many fund companies stay true to the concept behind these tools by keeping their fees low, others find ways to charge higher fees by stating that their fund is “passively managed”, and is therefore worthy of such additional costs. My advice is to steer free of these funds and to instead seek out those which are directly aligned with the corresponding index for which they are named. After all, there’s nothing more infuriating than to find that the fund within your portfolio, is costing you more than one which tracts the exact same index does in someone else’s’ portfolio, simply because you failed to read the fine print before you decided to purchase it.

There’s no doubt that mutual funds are good for investors. Their built in diversity alone makes them a worthwhile product to use, and for those seeking to invest in the stock market in a more safe and inexpensive manner, there simply is no better choice. So certainly, no investor will complain that there should be a cost associated with purchasing these products, or that a salesperson might receive a fee after advising them to do so. The problem arises however, when the investor isn’t informed of appropriate alternatives to the funds being offered, and that the disclosure of such fees isn’t properly explained to them at their time of purchase. Now you know.

(Anthony Rhodes is a Registered Investment Advisor and owner of wealth management firm The Planning Perspective www.theplanningperspective.com)