There are thousands of mutual funds of all stripes to invest in. Some focus on specific sectors like tech or energy, while others track data like the general market or the S&P 500. But they all have one thing in common. Payments are common.
When it comes to choosing the best mutual fund for you, the most important thing you can do as an investor is make sure you understand the fees involved with each fund. There are two types of fees that almost all mutual funds charge: shareholder fees and operating fees. And the amount they charge can vary, sometimes by huge margins. These fees can eat up thousands of dollars in profits in the long run, so you definitely want to know how much you’ll be paying before you start investing.
But it is worth paying the fees, especially low. By investing in mutual funds, you are actively creating an investment portfolio that helps you build wealth. Once you understand what fees to look for and which ones to avoid, you can take advantage of the wide range of benefits that investing has to offer.
In this article, we’ll discuss what these fees are and what to look for, how much a good amount is, and why they’re worth it once you find the right mutual fund.
Two major mutual fund fees
There are two main fees for mutual funds:
- Shareholder payments – Commissions and other one-time costs when you buy or sell and sometimes exchange mutual fund shares.
- Operating fees – Ongoing fees that a fund charges to pay for day-to-day fund management.
Both of these fees are disclosed in the prospectus, which is a legal document required to be filed with the Securities and Exchange Commission (SEC), which regulates the securities market.
Typically, they pay higher fees for funds that are actively managed or seek to outperform the overall market, but lower fees for passively managed funds that track an index. Actively managed funds tend to have higher payouts because there is a team of advisors behind the computer looking to beat the market.
“In the last couple of years, they’ve been coming down because of competition,” said Tanya Taylor, founder and CEO of Grow Your Wealth. This is good news for investors.
Types of shareholder payments
While operating expenses make up the lion’s share of your payments, look for other payments to shareholders.
Here are the most common ones:
Also known as a short-term redemption fee or exit fee, it is what investors pay when the fund’s shares are sold before a certain period of time, ranging from a few days to more than a year.
This fee is intended to discourage short-term investing and excessive trading, which should not be an issue for long-term investors. It’s a fee to the broker, Taylor says, and can run about 2% of the total sale.
If you want to transfer your money to another fund within the same broker or fund family, you may see this fee to make the trade. Some brokers charge this fee, while others do not.
This is simply a fee to hold and maintain your account, especially if your balance falls below a certain threshold. This is especially important if you have multiple accounts or funds.
Taylor says you can think of it as a low maintenance fee like some bank accounts have, but for a mutual fund.
This is a fee that some funds charge investors when they buy mutual fund shares. It is completely different from the sales load or commission paid to the broker to buy a fund.
Load and no-load funds
Another stock charge to note is the sales load.
The load is the commission paid to the broker when you buy or sell mutual fund shares, calculated as a percentage of how much you invest in the fund. This fee can range from 3% to 5.75% and is a one-time fee, says Jennifer Weber, a certified financial planner and vice president of financial planning at Weber Asset Management.
You pay this fee when you buy, when you sell, or every year, depending on the type of fund unit. A-class funds charge a sales load at the time of purchase, B-class funds charge at the time of sale. C-class funds have an annual commission, or you may have a fee when you sell the fund. Be sure to look for this payment, so you can expect it if it is paid.
Remember, many mutual funds have no sales loads or transaction fees, which is a big selling point. Weber advises clients to “always avoid loads and invest strictly in no-load funds that don’t have that commission piece.”
Many of the best funds are no-load funds and excellent investment choices, so be sure to check this fee, which is always available in the fund’s prospectus or on the fund’s website.
Annual fund operating expenses
Operating fees cover the administrative costs of managing, marketing and selling the fund, and are paid as a percentage of the fund’s net average assets. They also cover administrative costs. Above all, the broker must cover their business expenses related to managing the fund.
The most common operating charges are as follows
- Management fees – This goes towards paying fund managers (especially if the fund is actively managed) and advisors.
- 12b-1 fees – This fee covers the cost of buying and selling the fund and is 1% per annum (.75% for distribution and marketing and .25% for fund servicing).
- Various fees – These may include legal, accounting, transfer and other administrative costs.
While management fees are ubiquitous, many funds are reducing 12b-1 fees, Taylor says. It tends to be one of migrant payments, and Weber doesn’t like to invest in available funds. If the fees seem high, it’s worth checking out how much 12b-1 and miscellaneous fees might cost.
What is the standard mutual fund fee?
Mutual fund charges are expressed as a percentage of your total investment or expense ratio. They typically range from .5% to 1.5% for actively managed funds and .2% for passively managed funds. The most important thing to note here is that a fee of more than 1% is excessive and should be avoided at all costs.
For example, if a mutual fund has an expense ratio of 1%, that means you pay $10 for every $1,000 you invest. It may not seem like much, but it adds up over time.
Experts recommend that under .2% is a good payout and anything over 1% can eat into your investment returns in the long run. If you see a fee above 1.5% and definitely above 2%, know that you can do better. Many funds have fees of .2% or less, which is why experts recommend hedge funds.
Weber likes mutual funds. An expense ratio exists for a reason.
A good expense ratio for a passively managed mutual fund that tracks an index is .2% or less. Anything over 1% is too expensive, and you want to avoid it.
How are mutual fund fees paid?
Mutual funds do not look at receipts for any fees they charge. Instead, they will be deducted directly from your account. Because of this, you may not notice them unless you take the time. That’s why it’s important to dig into the fund’s future to spot any fraudulent charges, especially if it’s not a well-known mutual fund.
Make sure you know the expense ratio before you start investing. A 1% fee may not seem like much, but it can eat into your profits significantly over time.
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