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Mutual funds are still considered one of the easiest, simplest and most affordable ways to invest in the funds market.
The US Securities and Exchange Commission (SEC) identifies them as “companies that pool money from many investors and invests the money in stocks, bonds, money-market instruments, other securities, or even cash.”
Benefits Of Investing In Mutual Funds
Before we take on discussing the costs associated with mutual funds, let's take at some of the reasons why they are such an investment:
Simple and Accessible Option
It's not necessary for investors to have any prior financial or economics background and knowledge. When you put your money in a mutual fund, a professional manager will take care of the investment.
Build a Diversified Portfolio
A major rule in finance is to build as much diversified portfolio as possible in order to manage the investment risk. Mutual funds can help you diversify your portfolio because they invest in hundreds and even thousands of various assets. Recommendation: put your money in several different mutual funds. This will even lead to a better investment portfolio.
Not only are they easy to access but also quite accessible. Initial investment could be as low as $100. If you are investing on your own, how many assets can you purchase for $100? Not many. Can you build a diversified portfolio? The answer is no.
Team of Professionals
This is one of the greatest advantages, especially if you are a rookie and have no knowledge of the market. You shouldn't worry because a team of pros will take care of the investment strategy. This will save you countless hours of hard work researching the market as well as pitfalls down the road.
Now that you know the basic advantages of investing in mutual funds, let's see what are the fees and expenses an investor has to pay.
What are the Disadvantages of Mutual Funds?
One downside of mutual funds face is that they have hidden fees, especially the 12b-1 fees. Typically, not all mutual funds charge this fee. Therefore, before investing in a mutual fund, request your broker to disclose all potential charges.
Another drawback lies in poor trade execution. Generally, regardless of the time you enter a trade, the trade will always close at the end of the day. This is not tenable for day trading.
In addition, it takes longer to access your funds in mutual funds, unlike while investing in stocks or EFTs. It can take a day to access your money.
Besides, some funds have high capital gains, which they pass to investors as taxable events. If you do not like how this impacts your returns, look for index and tax-efficient mutual funds. Also, 401ks and IRAs are not affected by this drawback.
Fees and Expenses Associated With Mutual Funds
According to the SEC, there are two main groups of fees and expenses:
- The first group's name is “Shareholder Fees” and include all charges imposed on buying, selling or exchanging mutual funds. They could be front- and back-end sales loads, redemption fees and others.
- The second main group identified by the “Operating Costs”, which stem from the management of your account. They are several types, such as management and distribution fee as well as other expenses.
1. Front-End Sales Loads
This is the amount of money an investor pays when buying shares with a broker or a financial advisor for their services. Usually, this fee varies between 5% and 8.5% (the Financial Industry Regulatory Authority does not allow sale loads to exceed 8.5%).
Let's assume your initial investment is 5,000$ and the front load is 6%, which makes $300% is the sales commission you have to pay the mutual fund. This makes your actual amount of investment $4,700.
2. Back-End Sales Loads
This type of load is charged only when an investor sells shares. Normally, the amount of back-end sales load is a percentage of the share value.
For example, you invest $5,000 in a mutual fund charging 6% back-end sales load and when buying a fund's shares you will have $5,000. Should you sell the share, the fund will impose the charge.
3. Redemption Fees
Some mutual funds have fees when investors redeem their shares. Usually, it's a percentage of the redemption price and its purpose is to discourage traders from short-term investments. Unlike back-end loads that are used to pay a broker his commission, these fees go back to the fund itself.
4. Other Shareholder Fees
Some of the other shareholder fees might include account fees, purchase fees, and exchange fees. Some funds impose an account fee for the maintenance of your account. Most mutual funds charge an exchange fee if an investor transfer shares from one fund to another.
Purchase fees are imposed when a trader buys shares from the funds. This fee is not the same as a front-end load, and the former is distributed to the fund itself and the latter to the broker.
5. Management Fee
All mutual funds have a team of pros and advisers and you, as an investor, should pay them for their services – researching and picking up the best assets and managing the investment portfolio in general. Each fund has a management fee and it's usually a percentage of the total value of the fund. The range of management fee is normally between 0.10% and 2%.
6. Distribution Fees
Also known as marketing or 12b-1 fees. Distribution fees are charged to cover distribution, service or marketing costs. They usually start at 0.25% and reach a maximum of 1% of the fund's net assets. How is this fee calculated? It has two parts: marketing and distribution fee, which can amount up to 0.75% (maximum). The second part is service fees which can be a maximum of 0.25%.
7. Other Expenses
Sometimes there other operating expenses which we do not categorize as distribution or management fees. However, they also contributed to a fund's operating costs. For instance: legal expenses, administrative costs, certain shareholder service expenses, accounting costs, etc.
Mutual funds are easy and accessible financial tools. Despite that, a future investor would like to be aware of all the expenses, costs and fees that go with a mutual fund.
How Do I Avoid Mutual Fund Fees?
Generally, it is hard to avoid mutual funds fees because of their structure. However, there are multiple strategies to reduce mutual fund charges.
One method involves investing in a mutual fund that offers no-load on investment. Here they do not charge your capital on investment.
Buy a mutual fund that advocates passive management. Actively managed mutual funds require active involvement of managers in decision making, hence charge higher fees than passively-managed mutual funds.
Also, consider large investments opportunities. Small companies may offer lucrative returns but are riskier and attract higher charges.
Invest in a mutual fund that offers free brokerage commissions. In this case, your investment will grow without attracting commissions or taxes fee.
Do all Mutual Funds Have Fees?
Typically, all mutual funds charge fees. One prevalent fee is the expense ratio or management fee, or sometimes the operation fee. It is usually a specific percentage deducted from your investment before your share price is determined.
Another fee is the sales charge or the commission, which is an upfront cost of buying a mutual fund share. A common term in this reference is no-load or load fee.
There are also short-term fees to discourage trades from exiting their investments too soon. It is imposed when traders buy and sell stocks within 30 to 90 days.
Also, there are redemption charges. These are fees you pay the fund when selling your shares.
In addition, there are 12(b)1 fee or service fee, which serves as compensation to the financial advisor for marketing the fund.
How Should You Select Mutual Funds for Your Portfolio?
Mutual fund investors should adhere to a few general guidelines. To begin, keep an eye out for a performing fund. Ascertain that the fund's track record has not been marred by volatility. This must be tied to a consistent return for at least three years.
In addition, the fund must be consistent with your long-term financial goals. As a result, the fund must provide not only reasonable returns but also relatively low risks.
The terms of a fair deal should be open and not left to the discretion of the fund managers. The management team's discipline and reputation should also be intact.
When looking for the best company, make sure they provide no-load funds. Reduced broker fees and sales charges will allow you to earn a reasonable return on your investment.
Mutual funds, while attracting low risks, also earn low-medium yields. On the negative side, they have higher fees than stocks. Stocks, on the other hand, are riskier, but their potential reward is medium to high. Their investment is in the ownership of a company. That is, as the company grows into a behemoth, so will the shares.
A mutual fund's fund managers do not always invest in stocks. To protect investors from adverse risks, they diversify their portfolios with bonds or other debt securities. As an investor, you must weigh your risk tolerance against your income objectives.
In general, a mutual fund is a better option if you have a low risk tolerance. Invest in stocks, on the other hand, if your goal is a higher reward without being bothered by the risk level.
Setting up a Monthly Income Plan (MIP) mutual fund is the best way to earn a consistent monthly income. The fund is classified as a debt or hybrid fund. It enables investors to receive monthly dividend payments while lowering their risk exposure.
Typically, the fund is more conservative because only a small portion of the assets are invested in stocks, while a larger portion is invested in secure securities.
When compared to other financial instruments with similar goals, such as FDs and PPFs, MIP provides more stable returns during inflation. Furthermore, they are subject to lower taxation. MIPs, on the other hand, do not guarantee a consistent fixed monthly income. The fund, like any other portfolio, has drawbacks.
For example, if the economy is unstable, your fund may not pay consistent monthly dividends.
Late payments are reported to the credit bureaus and will be listed on your credit report. However, the reporting date is generally 30 days or more after the payment due date. This makes it possible to make up a late payment before it appears on your credit report.
So, if you are a day or two late making a payment, don’t delay and get the account brought up to date quickly, so it will not show as a late payment on your credit report.