An investor builds wealth in part by achieving a reasonable rate of return on monies invested and reinvesting those earnings to generate additional income. But regardless of the success of a mutual fund in generating gross returns or the steady compounding of earnings, the investor keeps only a net return on his investment. As a result, mutual fund fees and expenses, which negatively affect the investor's return, are important factors that influence the success of any mutual fund investment.
In addition to operating expenses, fund investors incur additional fees such as sales charges, which compensate individuals who sell fund shares to investors. These charges are referred to as sales loads and are paid when the investor buys shares in the fund, when he redeems fund shares or some time in between. A front-load is calculated on the value of the initial investment, and a back-load is based on the investment's value at redemption. For example, a contingent deferred sales charge is a back-end sales load, the amount of which depends on the length of time the shares are held by the investor. The CDSC might be 4 percent for an investment held less than one year, 3 percent if the investment is held two years and so on until the fee is zero. A fund that imposes a CDSC fee may also charge a 12b-1 fee, which is an on-going fee that covers the fund's marketing and advertising costs.
Effect of Sales Fees
Although the Financial Industry Regulatory Authority limits the size of the sales loads to 8.5 percent, such fees have a negative compounded effect on the investor's return from the point of the initial investment. For example, a 5-percent front-end load for a $10,000 investment that earns 8 percent will reduce the initial investment by $500 to $9,500. As a result, the investor's return is reduced over 20 years by $1,937, which is the 8-percent return on $500 compounded quarterly for 20 years.
Other Fund Fees
Mutual fund fees, in addition to sales loads, are documented in the fee table of the fund prospectus. Such fees might include a redemption fee of up to 2 percent of the sale proceeds. The fund collects this fee to cover the cost of processing the redemption of fund shares. The fund may also charge an exchange fee if a shareholder exchanges shares in one fund for those in another fund within the same fund group. An investor may also pay an account fee if his account balance falls below a predetermined amount as well as a purchase fee when he purchases fund shares.
Mutual Fund Fees and Performance
A fund that imposes high fees and expenses must deliver performance that is significantly better than that achieved by other funds whose performance is less affected by such fees and expenses. For example, a front-load charge of 4 percent means that only 96 percent of an investor's initial contribution is actually invested in fund shares. As a result, the fund must achieve a rate of return that is 4 percent higher than another fund's return, which is not saddled with this sales charge.
- Practicing Law Institute: An Introduction to Mutual Funds
- General Accounting Office: Mutual Fund Fees: Additional Disclosure Could Encourage Price Competition
- Mutual Funds : Your Money, Your Choice: Take Control Now and Build Wealth Wisely; Charles Parker Jones
- U. S. Securities and Exchange Commision: Mutual Fund Fees and Expenses
Billie Nordmeyer works as a consultant advising small businesses and Fortune 500 companies on performance improvement initiatives, as well as SAP software selection and implementation. During her career, she has published business and technology-based articles and texts. Nordmeyer holds a Bachelor of Science in accounting, a Master of Arts in international management and a Master of Business Administration in finance.