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Guide to Mutual Fund Fees

Posted By Jim On 11/20/2007 @ 8:57 am In Investing | 9 Comments

Interested in learning what a Sales Load is on a mutual fund? What about 12b-1 fee? Well, all of them are outlined in this SEC document on mutual fund fees [3]. What? You don’t really want to read that huge thing and you would prefer that I just give you a quick one or two sentence synopsis of each fee? Well it’s your lucky day because I’ve done just that. Ultimately, it’s a pretty straightforward list. It’s broken up into two types of fees, shareholder fees and fund fees. Shareholder fees are those fees that you pay out, fund fees are those fees or expenses that the fund pays out to stay in operation.

First things first, the list below is just a general description of what each fee is and what it generally covers in terms of the mutual fund operation. For the actual fees related to your mutual fund, you will want to get a copy of your prospectus and look for a fee table for the actual amounts you’re paying.

Shareholder Fees

These are all fees that the investor will see deducted from their accounts to go to the fund itself.

  • Sales Load – This is the commission the fund pays to brokers for pimping out their funds. The SEC doesn’t limit what a fund can charge but the Financial Industry Regulatory Authority (used to be the NASD) limits its members to a maximum of 8.5%. Sales loads come in two types – front end and back end.
  • Sales Charge on Purchases – This is a front end sales load and the fee is paid when you purchase and directly taken from your investment amount.
  • Deferred Sales Charge – This is a back end sales load and the fee is paid when you redeem your shares. Generally the percentage is calculated on the lesser of the investment amount or the redemption amount. That means if your shares have appreciated, they will take a percentage of the initial invested amount. If your share shave fallen in value, they will take a percentage of the selling amount, which is good for you in either case.
  • Contingent Deferred Sales Load – This is a sales load that decreases with time and is designed to entice investors to hold onto their investments. Generally they’re structured like this: The fee taken out is 4% if you redeem within one year, 2% within two years, 0% if redeemed after two years.
  • Redemption Fee – This is a fee that’s charged when you redeem your shares, which kind of sounds like a back end sales load to the investor but technically isn’t. It’s not a sales load because the redemption fee is used to pay for the redemption and not paid out to a broker for securing the sale. The SEC limits the redemption fee to 2%.
  • Exchange Fee – Want to trade in your shares for another mutual fund in the same class? That’s an exchange fee.
  • Account Fee – This is an account maintenance fee.
  • Purchase Fee – Again, this smells like a front end sales load to the investor but the funds don’t go to a broker, they go to the fund and not to a broker.

Annual Fund Operating Expenses

These are fees that the fund pays out to its management and these are also governed by the SEC rules. You’ll often see these values expressed in total as an expense ratio.

  • Management Fees – This is how much the investment adviser, managers, and their affiliates get paid out as well as any administrative fees that don’t happen to fall under “other expenses” below.
  • Distribution [and/or Service] (12b-1) Fees – This little guy gets all the press, or at least it used to get all the press, back in the day. Distribution fees are governed by the 12b-1 SEC rule and was sticky because its this fee that the fund can use to pay out commissions to brokers, which essentially is hiding a sales load inside an otherwise innocuous looking marketing charge (distribution also covers the printing of prospectuses, advertising, etc.). While the SEC doesn’t regulate how much a fund can charge, the FINRA does – it’s limited to 0.75% of the fund’s assets. Another part of this is the shareholder service fees and those are fees paid out to people to have them respond to shareholder inquiries and provide investors with information. Again, another way to hide some sales loads and again the SEC doesn’t regular the max but FINRA says 0.25% tops.
  • Other Expenses – This is the catch-all category of expenses for “everything else” like legal fees.

Why Index Funds Rock

See all those fees? Check out the Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) [4] and tell me what it says next to the 12b-1 Fee, Account Service Fee, Purchase Fee, and Redemption Fee? Right, it says none with the exception of a $20/year account service fee for balances under $10,000. If you crack open the Prospectus, on page 9 you’ll see that there are no sales loads whatsoever. Management expenses clock in at 0.16% and other expenses at 0.03%, the total expense ratio is a mere 0.19%. Index funds kick butt!

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[3] SEC document on mutual fund fees: http://www.sec.gov/answers/mffees.htm

[4] Vanguard Total Stock Market Index Fund Investor Shares (VTSMX): https://personal.vanguard.com/VGApp/hnw/funds/fees?FundId=0085&FundIntExt=INT

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