There are thousands of mutual funds of all stripes available to invest in. Some are focused on a specific sector, such as tech or energy, while others track an index, like the total market or S&P 500. But the one thing they all have in common is fees.
When it comes to picking the best mutual fund for you, the most important thing you can do as an investor is make sure you understand the fees involved for each fund. There are two broad types of fees that nearly all mutual funds charge: shareholder and operating fees. And the amounts they charge can vary, sometimes by huge margins. These fees can eat up thousands of dollars in long-term profits, so you definitely want to know how much you’re paying before you start investing.
But paying fees is worth it, particularly low ones. By investing in mutual funds, you are actively creating an investment portfolio that can help build you wealth. Once you understand what fees to look for, and which to avoid, you can take advantage of the massive benefits of investing.
In this article, we’ll talk about what these fees are and what to look for, how much is a good amount to pay, and why they’re ultimately worth it once you find the right mutual fund for you.
Two Main Types of Mutual Fund Fees
There are two major fees for mutual funds:
- Shareholder fees – Commissions and other one-time costs when you buy or sell, and sometimes exchange, shares of a mutual fund.
- Operating fees – Ongoing fees that a fund charges to pay for day-to-day fund management.
Both of these fees are disclosed in a prospectus, which is the legal record required to file with the Securities and Exchange Commission (SEC) that regulates the securities market.
For the most part, you’ll 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 fees because there is a team of advisors behind the computer looking to beat the market.
Types of Shareholder Fees
While operating fees tend to be the lion’s share of any fees you’ll pay, look out for other fees charged to shareholders.
Here are the most common:
Also known as a short-term redemption fee or exit fee, this is what investors pay when shares of the fund are sold before a certain period of time specified in the fund’s prospectus, ranging from a few days to more than a year.
This fee is intended to discourage short-term investing and excessive trading, which shouldn’t be an issue for long-term investors. It’s a fee paid to the broker, Taylor explains, and could run about 2% of the total sale.
If you want to transfer your money to another fund within the same brokerage or family of funds, you might see this fee to make the trade. Some brokers charge this fee, while others don’t.
This is simply a fee to have and maintain your account, particularly if your balance falls below a certain threshold. It’s especially important to note if you have multiple accounts or funds.
You can think of it like a minimum maintenance fee like some bank accounts have, Taylor says, but for mutual funds.
This is a fee that some funds charge when investors buy shares of a mutual fund. It’s completely separate from a sales load or commission paid to the broker to purchase a fund.
Load and No-Load Funds
Another shareholder fee to be aware of is the sales load.
The load is a commission paid to the broker when you buy or sell shares of a mutual fund, calculated as a percentage of how much you’ve invested in the fund. This fee can range from around 3% to 5.75% and is a one-time charge, says Jennifer Weber, certified financial planner and Vice President, Financial Planning at Weber Asset Management.
You’ll pay this fee at the time of purchase, at the time of sale, or on an annual basis depending on the class type of the fund. A-class funds charge a sales load at the time of purchase, while B-class funds charge it at the time of sale. C-class funds have a yearly commission, or may just have a charge when you sell the fund. Be sure to look out for this fee, so you can expect it if it’s charged.
Keep in mind, many mutual funds have no sales loads or transaction fees at all, which are big selling points. Weber advises clients to “always avoid load and invest strictly in no-load funds that don’t have that commission piece.”
Many excellent funds are no-load funds and great investment choices, so be sure to check for this fee, which is always found in the fund’s prospectus or on the fund’s website.
Annual Fund Operating Expenses
Operating fees cover the administrative costs to manage, market, and sell the fund, and are charged as a percentage of the fund’s net average assets. They also cover administrative costs. After all, the brokerage has to cover their business expenses associated with running the fund.
The most common operating fees are:
- Management fees – This goes to pay fund managers (particularly if the fund is actively managed) and advisors.
- 12b-1 fees – This fee covers the cost of marketing and selling the fund, and is capped at 1% annually (.75% for distribution and marketing and .25% for fund servicing).
- Miscellaneous fees – These could include legal, accounting, transfer, and other administrative costs.
While management fees are ubiquitous, many funds are cutting back on the 12b-1 fees, Taylor says. It tends to be one of the sneakier fees, and Weber doesn’t like to invest in funds that have it. If the fees seem high, it’s worth checking how much the 12b-1 and miscellaneous fees cost.
What Is a Normal Mutual Fund Fee?
Mutual fund fees are expressed as a percentage, or expense ratio, of your overall investment. 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 any fee higher than 1% is excessively high and should be avoided at all costs.
For example, if a mutual fund has a 1% expense ratio, that means you’ll pay $10 for every $1,000 you’ve invested. It doesn’t sound like much, but over time, it adds up.
Experts advise that under .2% is a good fee, and anything higher than 1% can eat into your investment profits long-term. If you spot a fee that’s over 1.5%, and certainly over 2%, know that you can do better. This is why experts recommend passively managed funds, as many funds have fees at .2% or below.
Weber likes mutual funds because “they’re a great way to be diversified with a small amount of money and have exposure to the overall market – and you can pick the fund to do that for you. There’s a reason why expense ratios exist.”
A good expense ratio for a passively managed mutual fund that tracks an index is .2% or less. Anything higher than 1% is too expensive, and you want to stay away.
How Are Mutual Fund Fees Charged?
You won’t see a bill for any fees that mutual funds charge. Instead, they’ll be automatically deducted from your account. For this reason, you might not even notice them unless you take the time to look. That’s why it’s worth digging into the fund’s prospectus to spot any sneaky fees, particularly if it’s not a well-known mutual fund.
Make sure you know the expense ratio before you start investing. A 1% fee might not sound like a lot, but over time it will eat up your profits significantly.
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