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 $100? Not many. Can you build a diversified portfolio? The answer is no.
Team of Professionals
This is one of the greatest advantages, especially if you are a rookie and have no knowledge of the market. You shouldn't worry because a team of pros will take care of the investment strategy. This will save you countless hours of hard work researching the market as well as pitfalls down the road.
Now that you know the basic advantages of investing in mutual funds, let's see what are the fees and expenses an investor has to pay.
Types of Fees and Expenses
According to the SEC, there are two main groups of fees and expenses:
- The first group's name is “Shareholder Fees” and include all charges imposed on buying, selling or exchanging mutual funds. They could be front- and back-end sales loads, redemption fees and others.
- The second main group identified by the “Operating Costs”, which stem from the management of your account. They are several types, such as management and distribution fee as well as other expenses.
1. Front-End Sales Loads
This is the amount of money an investor pays when buying shares with a broker or a financial advisor for their services. Usually, this fee varies between 5% and 8.5% (the Financial Industry Regulatory Authority does not allow sale loads to exceed 8.5%).
Let's assume your initial investment is 5,000$ 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.