Money Traps: How to Avoid Mutual Fund Fees

The mutual fund industry is famous for the complexity and opaqueness of its fee structure. Many investors are not even aware that they are paying fees, let alone what those fees are for or when they are assessed. Here are some tips on how to avoid mutual fund fees.

How Mutual Fund Fees Cut Into Your Returns

When you pay a mutual fund fee it’s not like writing a check for a monthly bill where you can see the withdrawal from your bank account. Rather, fund fees are baked into the returns.

Let’s say, for example, you invest in a fund that earns 10% in the first twelve months you own it. Assume further that it is a so-called “front-end load” fund, where a sales charge of 5% is assessed as soon as you purchase, and that the regular annual management fee is 1% (typical for an actively-managed equity fund).

In this situation, even though the fund earns a gross return of 10%, your net return – the amount actually credited to your account – is only 4%. The front-end load fee and management fee combine for a total of 6%. That’s money that will not go towards your long term investing goals.

Many Types of Mutual Fund Fees

Management fees and sales loads are common features of mutual funds, but there are other ways the fund companies and their distribution agents can reach into your wallets. Many funds feature 12b-1 fees – these are basically distribution charges paid by the funds to sales channel intermediaries and passed through to you, the investor, in an amount that can range from 0.25% – 1% of your invested assets.

Note that 12b-1 fees and sales loads are not the same thing, so it’s entirely possible for you to pay a 5% front-end or back-end load and a 12b-1 fee on top of the regular management fee. Yikes!

Another irritating class of fees is the redemption fee, which is typically assessed on investors who sell out of a fund position within a certain period of time. This can be anywhere from one month to one year or longer.

The stated goal of redemption fees is to discourage short-term trading in favor of longer term investing. That’s fine in and of itself, but a long redemption fee period can be a constraint in environments where selling out of a certain asset type is prudent.

How Can I Avoid These Mutual Fund Fees?

The short answer: read the fine print.

Have you ever heard those disclaimers at the end of a radio commercial? You know, the one in which a breathless voice rushes through all the things the ad sponsors are obligated to tell you, but don’t really want you to know? The mutual fund industry is like that.

Mutual funds are required to disclose every type of fee they assess, when they assess it and under what conditions, and how it affects your returns under different hypothetical conditions. Poring over prospectuses and statements of additional information (SAIs) is not most people’s idea of a great beach read – but it is in your best economic interests to do so.

Alternately, you can avoid mutual funds altogether and opt for passively-managed funds. Here’s a great discussion on active vs. passive funds.

And remember: Jemstep’s Portfolio Manager service will give you specific buy/sell recommendations based on the quality of funds (including the fees that they charge). That advice is custom-tailored to you, based on your age, risk tolerance and goals. And Portfolio Manager will include recommendations either spanning all funds, or only passive funds – whichever you prefer. So check it out – and cut some mutual fund fees from you accounts today.

Do you know what the funds in your portfolio charge? Tell us what you think.