Mutual fund investing is promoted as a way for people to get into stock-market or other investing with less risk, and while using financial experts to choose these investments. Of course, that financial expertise comes at a cost, in this case, through mutual fund fees. While usually quoted on the prospectus for a mutual fund as a small percentage, you cannot overlook the potential impact of these expenses on your potential return on investment. Trading costs, as well as the mutual fund manager's salary are examples of expenses, usually quoted as a percentage of the fund value.
Mutual fund fees can siphon the earnings from the mutual fund, and significantly reduce the amount of returns over the longer term. If a fund has average fees of 2 percent of the value of the fund, the fees are reducing the income produced on the fund by 2 percent. If the mutual fund was producing a 10 percent return on investment, it is now producing an 8 percent return when you factor in the fees. On a $100,000 investment, that is $2,000 each year.
Lower Available Investment
Loaded funds charge a fee, usually expressed as a percentage of your investment, in addition to management fees. In front-loaded funds, the fee is assessed at the time of fund purchase. While you do not have to pay this sales load each year, it does reduce the amount of your initial investment, and will impact returns. If you invest $20,000 in a mutual fund with a 5 percent load, 5 percent of your investment, in this case $1,000, is never invested in the fund. Your $20,000 investment becomes $19,000. Back-loaded funds assess their fee at the time of redemption, taking a percentage from your withdrawal.
Actively Traded Funds
Funds that trade stocks or securities more often than average are actively traded funds. With a stock-market mutual fund, each trade of stock within the fund costs money, because the fund must pay the sales commissions and other costs. A fund manager who is actively trading, trying to pursue the highest possible gains, may cost the fund more than the gains he is making through all his trades. An actively traded funds will usually show a higher expense ratio on its prospectus than other funds.
Index funds are traditionally the mutual funds with the lowest fees. An index fund invests its money evenly across a prescribed group of stocks to match the content of a stock index such as the Standard and Poor's 500. These funds typically do not trade stocks held in the fund, unless the index makes a change to its listings. As a result, their costs tend to be lower and more of your money stays invested.
The Big Picture
Fees do have an impact on a mutual fund's performance, but must be looked at in context. If a mutual fund has higher-than-average returns compared to similar funds, an extremely competent fund-management team may be in place, and may be compensated appropriately, resulting in higher fees. If the fees do not completely offset higher returns, the fund could still be a good value.