Online Calculators Can Help You Work Out the Long-Term Numbers
Everyone knows that mutual fund fees come in a wide array of confusing and often hard-to-decipher titles. So when you’re comparing one mutual fund with another, how do you know when your analysis is accurate? Even more important, how do you know whether what you’re being forced to pay is a good deal? You might come to the realization that you can do better making your own decisions and building a portfolio directly.
Even if you understand how these mutual fund fees work, side-by-side comparisons are tough because of how they’re calculated and the often confusing titles they’re given. Some fees are taken right off the top when you invest; others come out every month, at the end of the year or when you sell shares.
Making an accurate comparison is further compounded by terminology. Many mutual funds have figured out how to obscure what they charge by using different names for the same kinds of fees.
As a starting point you can go online and compare fees using one of several free calculators. There are many of these, offered by fund families or other services. Following this story is a listing of some calculators offered by regulatory agencies and financial sites.
Each calculator is a little different and some are variations of the same basic idea: Plug in the fund name and fees listed in the prospectus and then compare a typical investment amount over a period of years.
The comparison often is limited to no-load versus load funds. A load is a sales commission, deducted the minute you invest. At a rate of 8 percent, for example, this means that only $92 of every $100 invested goes to work for you; the rest goes to pay a sales commission.
If you’re capable of picking your own mutual funds based on performance evaluation and comparison of fees, there’s no need to pay a sales load. You can work directly with the management of a no-load fund by telephone or the Internet. Although salespeople promoting the load fund will claim that their funds outperform no-load funds, there’s no evidence that this is true.
A Fee for This, a Fee for That
Besides the well-known front-end load (meaning the fee is deducted when you invest), some funds also charge a back-end load, or a contingent-deferred charge. This charge comes out of funds when you redeem shares. The longer you leave funds on deposit, the lower this deferred load becomes. For example, the total fee might be 5 percent, with a 1 percentage point decrease each year.
Both front-end and deferred loads range between 4 percent and 8 percent. But the load fee is only the best-known of a range of fees that mutual funds charge. By obscuring the names and titles of fees and then deducting many of them each month, mutual funds don’t make it easy for shareholders to figure out what it costs to buy and own mutual fund shares. It amounts to more than most people might believe.
Management fees may also be called “advisory fees” and represent payments to professional managers for making portfolio decisions. For example, if the management fee is 0.75 percent, you’re charged $7.50 per year for every $1,000 invested. It’s deducted in small dollar amounts each day after the net asset value has been computed.
If you believe that this fee isn’t necessary, you might take a look at one of the dozens of exchange-traded funds, where management fees are much lower. This is true because the portfolio is fixed, so very little management is needed.
Directors’ fees, also called trustee fees, are paid by funds organized as trusts to the board of directors that monitors the management’s activities.
Administrative service fees cover the expenses of the management company in running the fund, researching and making portfolio decisions.
Other fees include legal expenses, audit fees and shareholder service fees, which cover the customer services provided, correspondence and sending out monthly statements. Shouldn’t this be part of the overhead covered in administrative service fees? This is a good question. Funds may also charge service fees, which are used to pay banks or brokerage firms for maintaining customer accounts.
Brokerage fees are charged for buying and selling securities. So the more volume of trading management executes, the higher the fees.
Custodial and transfer fees are paid to a bank or trust company to protect and keep the fund’s assets.
Interest is charged if and when the fund borrows money. This occurs to enable the fund to remain as fully invested as possible, while having funds available to pay investors who sell shares. This activity is likely to increase during volatile markets, so a fund is allowed to borrow up to one-third the value of its assets.
Redemption fees are flat fees taken whenever money is removed from an account. This is easily confused with a back-end load fee, but the redemption fee is charged regardless of how long shares were owned.
12b-1 fees are named for the Securities and Exchange Commission regulation that allowed funds to assess this charge. To many investors, this is an unfair charge. It’s used to pay for the effort of attracting new shareholders — in other words, to advertise the fund — and is taken out of each account every month, adding up to about $7.50 per thousand dollars, per year.
The many fees and charges of mutual funds are confusing and frustrating, because there’s very little about these charges that’s uniform. The management fee, a compensation for portfolio managers, can be among the highest of costs. But there’s a way to avoid these.
Now for Something Different: ETFs
A newer kind of mutual fund growing in popularity is the ETF, which is different from the traditional mutual fund in several ways:
1. The ETF has a predetermined “basket of securities.” Because the portfolio components are known in advance, management fees should be quite small. The only decisions to be made come up when a component has to be dropped and replaced from the basket. A predetermined basket of securities doesn’t improve diversification, though; in fact, it makes it worse. For example, a sector ETF is likely to see all its components lose value because of events that hurt the sector.
2. Shares are traded on the open exchanges just like stocks. This means they have greater liquidity. Traditional mutual funds are always bought or sold based on day-end net asset value (NAV). The ability to trade shares on the exchanges may also mean that fees for buying and selling are going to be much lower than transacting directly with a mutual fund’s management.
3. ETFs are set up to specialize in market sectors and many non-stock products. These include countries or regions, currency, commodities, debt securities and many other alternatives.
4. Fees are likely to be lower across the board. Because ETFs trade just like shares of stock, they’re easier to buy and sell, and it is much more difficult for fund management to “nickel and dime” shareholders with an array of expense fees, service fees, and administration and other charges.
Taken Together, It All Adds Up
The problem with mutual fund fees is that each specific one is quite small, but added together they represent a fairly big hit on your asset. This is especially the case of a front-end load, with money taken out of funds before they’re even invested.
The ETF solves some of the fee problems of mutual funds. But the real bottom line for anyone using mutual funds is this: The convenience of diversification and professional management can be very expensive. Making the fees even worse, most traditional funds underperform when compared with market indexes such as the Standard & Poor’s 500.
This is because as funds get larger, they have to diversify more broadly. The percentage they’re allowed to hold in any one company is limited by law; so the success of popularity translates to having to buy many stocks that the fund might not otherwise want to hold. Remember, too, that most of these fees are deducted from your account even when the fund loses money.
In other words, success has a price. And whether it’s an overt fee or a hidden cost, mutual funds don’t solve the problem investors face when seeking safety and convenience. A wise method for deciding whether to invest through mutual funds is to compare the cost to the alternative of buying stocks directly. For many investors, the alternative of researching and buying stocks through an investment club is a more sensible method for building a portfolio. It’s also much cheaper.
Mutual Fund Cost Comparison Calculators
Michael C. Thomsett is the author of more than 70 published books. Among these are Getting Started in Stock Investing and Trading (Wiley), which includes practical suggestions for picking stocks based on fundamental analysis. He is also the author of Annual Reports 101 (Amacom Books), Getting Started in Fundamental Analysis (Wiley) and Investment and Securities Dictionary (McFarland). He lives in Nashville, Tenn., and writes full time.
BetterInvesting Magazine is published monthly by BetterInvesting.
BetterInvesting is the brand identity of the National Association of Investors Corporation, a national, nonprofit association with members consisting of individual investors and investment clubs. Founded in 1951 and with headquarters in Madison Heights, Mich., BetterInvesting is considered the voice of the individual investor, as well as the pioneer of the modern investment club movement. BetterInvesting is dedicated to providing a sound program of investment education and information to help its members become successful long-term, lifetime investors. For more information about BetterInvesting, visit its website at www.betterinvesting.org.