Financial Savvy – Demystifying Mutual Fund Costs

Let’s be honest here. Most people don’t know much about investing. But as they say in law, ignorance is no excuse. Whether your financial goal is to pay for your kid’s college education or to fund your retirement, you still need to build a nest egg. And that’s not going to happen if you stick to low-interest bank savings accounts. So what’s the answer?  

The best advice to novice investors is to "just say no" to picking individual stocks and bonds. Instead, you’ll get better diversification – at lower cost – by investing in mutual funds, which pool investors’ dollars and buy a large number of investments with them. Your share of a mutual fund is therefore an ownership interest in a large portfolio. It’s important to understand, however, that the liquidity, professional management and diversification benefits offered by mutual funds aren’t free.

We can divide the sometimes-hidden costs of mutual fund investing into: 1) shareholder fees you pay directly, and 2) management costs you pay indirectly out of fund assets.

Unless you’re in a "no load" fund, you’ll pay one or more of the following types of shareholder fees:

– "Front end load," a one-time commission, averaging around 5 percent, paid when you buy the shares;

– "Back-end load," charged if you sell shares back to the fund within a certain period after your purchase. These often decline with time from purchase; for example, 5 percent the first year, 4 percent the second year, etc.;

– Exchange fee for transferring your money between funds in the fund family, as in the case when you move money from a stock fund to a bond fund;

– Annual account maintenance fee charged to cover the costs of providing services to investors with small accounts.

In addition to the charges paid directly by investors, funds incur management expenses, deducted directly from the funds’ assets before earnings are distributed. These impose an indirect cost, even on no-load investors, since they reduce the annual return on investment. They may include some combination of the following:

– Annual fee charged by the fund manager.

– 12b-1 distribution fees, which compensate sales professionals for marketing and advertising fund shares. These are limited to no more than 0.25 percent for no-load funds.

– Other operational expenses, such as the cost of maintaining customer accounts, the Web site, record keeping, printing and mailing.

Total management expenses usually range from 0.5 percent to 1.25 percent per year but can be higher. The Wall Street Journal mutual fund quotations include an indicator for each type of fee, although the actual amount isn’t reported. By law, the mutual fund’s prospectus, a document explaining the fund’s investment objectives and track record, includes a standardized fee table to help you compare the costs of different funds. You can request a prospectus from your broker or access it online.

Front-end loads reduce the amount of your investment. For example, $1,000 with a 5 percent front-end load gets you only $950 of shares. So if you earn $50 in dividends on the fund, you’ll only be back to the $1,000 you started with. If you’re a buy-and-hold investor, one-time loads aren’t as important as the annual management fees. Over a 10- or 20-year holding period, a one-time 5 percent commission is relatively insignificant. If you don’t sell, you’ll never pay a back-end load.  

Although a no-load fund might sound like the way to go, it will likely provide you less in the way of investment tools and financial advice and may charge higher management fees. You’ll obviously need to assess your objectives and time horizon, and then do your homework, before making this important decision. But don’t wait too long. The sooner you invest, the sooner you can start to build that next egg for the future.


Vickie Bajtelsmit, Professor of Finance

Colorado State University College of Business

(970) 226-1473