How to Create a Low-Cost Mutual Fund Portfolio

Mutual fund fees have generally declined, and that is good news for investors. Stock mutual fund investors paid an average expense ratio of 0.77 percent in 2012, down from 0.79 percent in 2011 and 0.83 percent in 2010, according to the Investment Company Institute. An expense ratio is a measure of a fund's total annual costs expressed as a percentage of the money it holds. While fees are dropping, you will still have some work to do to build a low-cost portfolio.

Fund Expenses

The first step in building a low-cost mutual fund portfolio is to be aware of what sales charges are included in the funds you are considering. A broker may take a commission up front when you buy the fund, as a continuous monthly fee or as a "surrender charge" -- known in the securities industry as a "contingent deferred sales charge" or "back-end load." The CDSC fee is taken if you sell a fund within a certain period, usually the first six years. Before buying a fund, ask what sales charges are included. You may also want to consider "no load" funds, those without sales charges. However, all mutual funds include "12b-1" fees, which include marketing and distribution costs. These are discussed in the fund's prospectus.

Management Style

Mutual funds are commonly available in two management styles: active and passive. Actively managed funds are run by investment managers who seek to out-perform the market. With research, management expenses and frequent trading come higher fees. On the other hand, passively managed funds seek only to track the performance of a market index and generally have lower fees by essentially duplicating the investments included in the index. For easy identification, passively managed funds will usually have the word "index" in their name.

Learning the Costs

The Financial Industry Regulatory Authority is an independent regulator of securities companies in the U.S. You can compare the fees and expenses of up to three mutual funds at a time using FINRA's online Fund Analyzer. With a database of more than 18,000 funds, this tool will show the impact of fees and expenses on a fund's return and will be helpful in building your low-cost portfolio.

Considerations

Building an effective investment strategy involves more than just buying mutual funds with low fees and expenses. You want to make sure a fund's investment goals and risks are a good match for your goals and that the fund provides a proper fit for the overall diversification of your portfolio, among stocks, bonds and cash, for example. You can read about a fund’s goals, risks and costs in its prospectus.