One of the most important factors to consider when evaluating a mutual fund is the assortment of fees that you may pay to buy, hold, and/or sell the mutual fund. However, there are many different types of fees that are charged to cover a variety of expenses, such as the portfolio manger’s salary, administrative costs, etc.
We can break these fees down into two categories: sales fees and the expense ratio.
Sales fees are the large, one-time fees that are charged when you buy or sell a mutual fund. Mutual funds with these types of fees are called load funds, and mutual funds without sales fees are called no-load funds. Breaking this category down further, load funds typically charge either a front-end load or a back-end load.
The front-end load is a fixed percentage fee (often somewhere around 5%) that goes to compensate the broker that is selling you the mutual fund. If you invest $10,000 in a mutual fund with a 5% front-end load, you are paying an extra $500 just to give your broker a commission.
The back-end load is often a variable percentage fee that discourages the investor from selling the fund within the first few years of ownership. For example, you could invest $10,000 in a back-end load fund, and if you sold it within the first year you would have to pay a 5% fee. However, each year the fee may decrease so that if you sell your shares six or more years from when you purchased them, the expense has disappeared.
Over the past decade, online discount trading and investing has become much more popular, and many funds now just charge an expense ratio each year. The expense ratio typically ranges between .5% to 1.5%, and includes the management fee, administrative costs, and sometimes a 12b-1 fee.
The management fee and administrative fee are typical and necessary to pay for professional management and administrative duties, but the 12b-1 fee is the one that you may want to avoid. This fee goes to pay for marketing and distribution expenses—you, the investor, are essentially bearing the burden of the mutual fund’s advertising fees and distribution costs. Expense ratios cannot be avoided, but should be minimized.
As you can see, mutual fund fees can be very large and can either take a portion of your investment up-front, or charge you unnecessary (12b-1) fees each year. While the management fee and administrative portion of the expense ratio shouldn’t concern you too much, you should also be wary of annual fees that are too high (above 1.5% per year). Now that you understand the basics of mutual fund fees, you should be better able to compare mutual funds to find the right one for you.