Mutual Fund Expenses and Fees

• Loads - these are fees typically charged when a fund is bought or sold
• Fees or Expense Ratio - The expense ratio or the fee is charged as a percentage of the assets for maintaining and running the fund. A good expense ratio is .25% (25 basis points)
• Transaction fees - ETFs and some mutual fees charge transaction fees that are like buying and selling a stock. Be careful with these. Small purchases can have fees that equal a high percentage. For example, if you pay $8 to purchase $100 worth of an ETF, then that's the equivalent of an 8% load.

Recent studies on mutual fund performance indicate that the best signal to the overall performance of a mutual fund are the expenses and fees associated with owning the fund. The lower the fund fees and expenses, the better the performance. This rule says find the funds with the lowest expenses and they will outperform other funds in their class. Funds that are actively managed tend to have higher fees, while index funds tend to have lower ownership costs.  Many experts are now advising people to own index mutual funds with low expenses that will match market performance vs trying to beat the market with managed funds that have more expenses.  There are many fees that can be associated with owning a mutual fund.  I'll go through the various fees and how to keep them as low as possible.

Loads on mutual funds are primarily used as a way to compensate brokers that resell mutual funds to investors.  There are two types of mutual fund loads.  Front end loads that investors pay when they make their initial investment into the fund and back end loads that they pay when they redeem their investment.

It's rarely necessary to pay loads on funds if you do a little bit of research.  Most funds or similar funds are available directly from fund families without loads.  I recommend looking for equivelent funds offered by Vanguard.  Vanguard offers many mutual funds without loads.

In a recent situation I saw,  which inspired this, a person inherit several mutual funds.  Many of the funds were Class A and Class B mutual funds.  Many people aren't aware of the different classes of shares in a fund and how the expenses are paid and how they affect performance.  If an investor owns a mutual fund and holds class A and class B shares in the same fund, the fund they own holds the exact same assets, however, the performance can be quite different.  Class A shares charge a load to the investor at the time the shares are purchased.  Class B shares charge a load to the investor when the shares are redeemed.  Some class B shares also waive the fee if the assets are held long enough.  If an investor finds them self in a situation with Class B shares, they need to find out if they owe the load on the entire current value of shares or the initial investment and to make a decision to continue to own the fund.  Class C shares might have a front end load or a contingent deferred sales load which is less than the Class A and Class B shares, but the Class C will not convert to another class of shares.  There is one last class of mutual fund shares called Class I that are sold to institutional investors.  I've never seen these types of shares, but they typically have their own fees and expenses.

I only buy no load mutual funds. No load mutual funds don't charge a percentage of the money you invest when you buy the fund and when you sell it. This is very important to keeping the cost of a mutual fund down. SEC says mutual funds can charge up to an 8.5% load on mutual funds. While I haven't seen any funds that charge this much, I have seen 5% loads. Imagine you invest $100. On a no load mutual fund, all of the $100 goes into your initial investment. If there was a load, this fee reduces the amount you have to invest. So on a 5% load, that $100 investment is now effectively a $95 investment.

Just because a fund doesn't charge a load, it may have other fees and expenses that still make the fund very expensive to own.  So there are still many other types of fees a fund can charge and still be called a no load fund, so it's very important to review all of the various charges.

Expense ratios is an annual fee charged by the fund for operations.  It's expressed as a percentage and typically charged quarterly to pay the fund.  Funds with high expense ratios (over 1%) can have a huge impact on the value of an account over time.  There are several expenses that are rolled up into the annual expenses the total cost of operations for a fund.

• Management fees are the fees charged to run the fund, they pay the people and costs associated with making the investments and the ongoing management.
  
• 12b-1 fees.  These fees are for managing distributions which are the capital gains, and dividends.  Investors have the option to reinvest dividends and capital gains or to get paid out.  The fees here go to covering these services.  Many good funds with low expenses don't charge 12b-1 fees.
  
• Other expenses.  These are a group of expenses from possibly accounting to shareholder services that aren't included in the management fees or the the 12b-1 fees.

Now that we have covered the two main expenses which are loads and the expense ratio of the fund, a fund can still have low charges in these areas, but still have more charges that investors have to pay.

No load mutual funds have to be under .25% of the net asset value with additional expenses to maintain their no load status according to the US government website.

• Redemption fee may be charged when the fund is redeemed.  This is different than the deferred load in that the fee typically goes to the fund instead of the broker.  Some funds charge short term redemption fees so investors don't move in and out of funds.  Redemption fees have to be less than 2% of proceeds.  2% is still outrageous.  I'd avoid funds with long term redemption fees.
• Purchase fee.  This is typically a flat fee paid when the mutual fund is purchased and different from a load as well.
  
• Account fee.  An account fee is charged by some fund families for maintaining an account with the fund.  Sometimes these fees are waived if the account maintains a certain balance.  It does discourage small investors in some ways since $20 fees in some cases can eat at a small account each year.
• Exchange fee.  This fee is charged when you switch between funds in the same family.  Not all funds charge this fee.

All of these fees are separate from loads and not included in the expense ratios of the fund.  Before deciding which fund to purchase, it's a good idea to look at all the fees associated with an investment and to do your best to limit all the expenses.

Remember, all of these fees and expenses eat at performance over the long term.  Even index funds that mirror the market will do slightly less than the actual index since the fees and expenses will bring the performance down a bit.

I keep my 401K money in a Vanguard Retirement date fund. Vanguard is among the lowest cost funds to own. The retirement funds hold three asset classes and adjusts the risk as I get closer to retirement.

For my personal account, I started using wealthfront.com. They use Modern Portfolio Management with six asset classes. Then, based on my risk profile they invest in low cost Vanguard ETFs. They regularly rebalanced my holdings and they'll weight out each additional investment I make in the right ETFs. For this they charge 25 basis points on top of the fees for owning the ETFs. So far they have done a great job. The fees are still lower than most mutual funds and I'm getting the benefit of non correlated asset classes through low cost ETFs.