If you think mutual fund performance is the whole story, watch out! You could make a very expensive mistake by not considering the costs of a mutual fund! The lower a funds costs, the higher percentage of your funds real return you receive. You can control what you pay to invest by selecting low cost mutual funds.
Mutual fund costs come in two flavors:
1) Shareholder Fees
You pay these fees directly out of your own pocket to purchase, redeem, or exchange shares. The following shareholder fees will appear in the Fee and Expenses section of a mutual funds prospectus:
Sales Charge on Purchases – Also called a Load, this fee is expressed as a percentage of the dollars invested
Purchase Fee – Usually replaces the sales charge / load. This fee appears as a flat dollar charge for making a purchase regardless of the investment amount
Sales Charge on Reinvested Dividends – Similar to the Load on purchases, this fee is expressed as a percentage of dollars reinvested
Redemption Fee – Charged at the time of selling shares of the fund. Expressed as a percentage of the dollars invested or a flat dollar amount
Account Maintenance Fee – A flat dollar amount charged if your account value falls under a specified minimum balance
2) Annual Operating Expenses
These expenses get deducted from the Funds assets before the management firm calculates return numbers.
Management Fee – This fee gets paid to the team that makes all the investment decisions. Out of this fee, the fund management pays for trading costs so you wont see commissions detailed in the expense section of the prospectus.
12b-1 Distribution Fee – This fee covers the costs of advertising and selling the fund. These fees are ongoing, meaning they never go away for as long as you own the fund. They can have a significant negative impact on the cost of a fund.
Other Expenses – This includes the cost of daily administration of the fund such as issuing annual reports, maintaining office space, etc.
How much you should expect to pay depends upon the mutual fund category. Each category has its own average annual expense ratio. For instance , it costs more to run an international fund than a domestic. Bond funds cost less to run than equity funds. To find out the categorys average expense ratio, go to Morningstar and view the report for the fund youre considering purchasing (simply input the funds symbol in the Quote box and hit “enter”) once the report appears, go to the Fees and Expenses. The category average expense ratio appears in the Actual Fees section on the right.
All things being equal (i.e., risk, performance, etc.), you want to select mutual funds that have low expense ratios relative to other funds in the same category. You can compare the cost of various funds for free by using Vanguards Cost Comparison tool or the Morningstar Fund Compare. If you have a membership at Morningstar, check out the Cost Analyzer found in the Morningstar Tools section (right side of the page).