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It's a fact. The higher the fees you pay while owning a mutual fund, the lower the returns generated by your fund shares. Even a small percentage difference in fees between funds can add up to a big difference in the dollars you can make.
All mutual funds charge fees. They fall into two broad categories: fees charged on an ongoing basis, usually annually, and fees you pay when taking certain actions. Mutual funds are required to describe their fees in detail in their prospectus. Always read a fund's prospectus before investing.
Some of the ongoing fees that cover a fund's annual operating expense include:
- Management fees. These are likely the highest fees you'll pay. They compensate the mutual fund's portfolio manager or investment advisor who directs the fund's stock or bond portfolio strategy. The advisor plays the key role in driving a fund's performance.
- 12b-1 fees. They take their name from the section of the securities law that created them. These fees are taken out of a fund's assets to pay for the cost to market and sell the fund, but can't exceed 1% of those assets. Brokers and other investment professionals can also be compensated with these fees.
- Other expenses. This miscellaneous category includes the costs of services provided to shareholders that fall outside the expenses covered by 12b-1 or portfolio management fees.
And here are some additional fees you can be charged when you take certain actions:
- Account fees. Funds may charge you a separate fee to maintain your account, especially if your investment falls below a minimum dollar amount.
- Redemption fees. You incur these fees if you sell fund shares shortly after buying them. They are meant to discourage short-term trading and can apply up to a year. Find out if a fund has a redemption fee and how it's calculated, especially if you might need to sell your shares soon after buying them.
- Exchange fees. Some funds charge exchange fees for moving your money from one fund to another, even if offered by the same investment company.
- Purchase fees. These might be assessed at the time you buy shares of a fund, whether or not you also pay a front-end sales load. They are paid to the fund and not to the selling brokers.
- Transaction fees. These fees are paid to brokerage firms to execute a fund's buy and sell orders. Transaction fees can vary from fund to fund. The more active a portfolio manager is in buying and selling securities, which is reported as the turnover rate, the higher the transaction or trading costs are likely to be.
How to compare fund expenses
There is a figure that makes it easy to compare the overall expenses of one fund with another. It's called total annual operating expenses. Also known as a fund's expense ratio, it measures the costs of running a mutual fund. You can find a fund's expense ratio in its prospectus or on its website.
The expense ratio tells you the percentage of a fund's total assets that goes toward paying its recurring fees every year. The higher a fund's fees and expense ratio, the harder it is for the fund to beat its market benchmarks. Suppose you're considering two similar funds, Fund ABC with an expense ratio of 0.75% of assets and Fund XYZ with a 1.85% ratio. Right off the bat, for Fund XYZ to match Fund ABC in annual returns, its portfolio would have to outperform Fund ABC by more than a full percentage point.
Fees do matter. And remember, the expense ratio does not include any sales loads, which funds might charge when you buy or sell shares.
Use FINRA's online Fund Analyzer to compare mutual fund fees, sales loads, and other expenses that can affect your return. This tool has up-to-date expense information for thousands of funds.
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