When you’re investing in mutual funds, fees are a fact of life.
Mutual fund fees fall into two categories: shareholder fees and operating expenses. You pay shareholder fees if you buy load funds, redeem shares within a restricted period, or allow your account balance to fall below the required minimum. But you pay operating expenses whenever you own fund shares.
These are asset-based fees that are typically calculated daily and subtracted from the fund’s net assets before investment gains or losses are credited to your account. Anything you pay in fees isn’t reinvested. So the higher the fees, the more potential earnings you lose out on.
The operating expenses cover the cost of running the fund and generally include:
- Investment management fees, which often account for the lion’s share of the total
- Administrative fees
- 12b-1, or marketing and distribution, fees
These fees are usually quoted as an expense ratio, or a percentage of the fund’s net assets, and range from less than 0.1% to 2.75% or higher in some cases. The fees vary from one fund company to the next, and from one fund to another within the same fund family.
Not surprisingly, actively managed funds tend to have higher management fees than passively managed index funds. And the more time and resources that are required to make investment decisions and execute transactions, the higher the fees are likely to be. This helps to explain why actively managed international or global funds tend to be the most costly.
Competitive pressure has brought some fund fees down, especially at several of the largest no-load companies. And other funds have been required to reduce or clarify their fees as part of legal settlements or SEC disclosure rules.
What you pay for?
A fund uses management fees to compensate its manager, who’s responsible for choosing securities for the fund’s portfolio — and whose expertise often attracts investors to the fund.
When the fee is calculated as a percentage of the fund’s assets under management, the manager is rewarded for increasing the value of the fund. In some funds, there may be a bonus for beating the fund’s benchmark index. Additional performance payments may be made as well, depending on how the fund fares.
In other cases, fees paid to investment managers may be reduced, on a percentage basis, as the assets under management increase. That wouldn’t necessarily reduce the dollar amount of the manager’s compensation, because the base would be larger. But it could save individual investors money.
What are 12B-1 fees?
Named for a provision of the Investment Company Act of 1940 that authorizes them, 12b-l fees pay for a fund’s marketing and distribution expenses and certain shareholder services. According to FINRA rules, 12b-1 fees may be up to 1% of a load fund’s total assets, with no more than 0.75% going toward marketing and distribution. Some funds use these fees to pay broker fees rather than charging a front-end load. Both load and no-load funds can use 12b-l fees for shareholder services, capped at 0.25% of assets.
These fees tend to be controversial and may be revised. Advocates argue that marketing adds value to the fund by attracting new investors. Opponents believe that these fees, which may have been relevant when the mutual fund industry was new, are no longer justified.
Mutual Fund Fees. How Much Do You Pay? by Inna Rosputnia
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