Source: The Motley Fool.
After five years of a strong bull market, most investors feel a lot better about their stocks and mutual funds than they did during the lows of the financial crisis. Years of double-digit annual percentage gains have given investors the idea that it's easy to make money in the market. Compared to those returns, the fees that most investors pay look relatively small.
But bull markets don't last forever, and the volatility we've seen over the past few weeks should serve as a wake-up call that it's important to preserve as much of your profits from good markets as you can in order to get through the bad markets. By focusing on not paying too much for your mutual funds, you can clamp down on costs and keep most of your money for yourself. Let's take a look at five signs that you're paying more than you should for your mutual fund.
1. Your mutual fund charges a sales load
In the distant past, it was hard to buy a mutual fund without paying a sales load. The load is basically a one-time upfront commission that the fund pays directly to your broker, and many brokerage firms argue that those loads are what enable investment professionals to offer what they typically call "free" advice to their clients.
The biggest problem with the sales load is that it's charged on a percentage basis, with typical loads ranging from around 3% up to as much as 8.5%. At the high end of that range, if you make a $10,000 investment, you'll only have $9,150 invested in the mutual fund of your choice, with the other $850 going directly to your broker.
Moreover, there's no evidence that funds that charge sales loads perform any better than mutual funds that don't charge them. In fact, given that loads put you in a big hole from the outset, only the rare outperforming mutual fund can overcome that deficit and earn you returns as good as a comparable no-load fund. That's why avoiding load funds is typically a smart move.
2. Your mutual fund charges a 12b-1 fee
Unfortunately, sales loads aren't the only fees with a dubious connection to your investing results. The 12b-1 fee refers to the section of the securities law that authorizes the fee, and it basically allows your mutual fund to collect money to pay for marketing and other related expenses.
The 12b-1 fees tend to be smaller than sales loads, with typical fees ranging from 0.25% to 1%. But unlike the one-time sales load, 12b-1 fees are collected on an ongoing basis, with those percentage fees taken out each and every year. Over the long run, therefore, 12b-1 fees can have an even bigger impact on your total return than a sales load. Again, there are plenty of no-load funds that also find ways to cover their marketing costs other than than charging you directly from the amount you have invested in the fund.
3. Your mutual fund has annual management fees of more than 1%
With the rise of index mutual funds and exchange-traded funds, it's easy to find funds that will charge you a mere pittance to invest. Some of the largest index funds have management fees of 0.1% or less, and many ETFs charge fees of less than a quarter of a percent.
By contrast, active management entails higher costs, as your fund managers are engaged in trying to find stocks or other investments that will beat their benchmarks. But even among actively managed funds, the average annual expense ratio fell to 0.89% in 2013, according to the latest available figures from the Investment Company Institute. If you're paying more than 1%, then you're well above the average -- and you really need to ask yourself whether the advice you're getting is worth the price you're paying.
4. Your mutual fund's long-term average returns aren't keeping up with the fund's benchmark
No matter what you're paying in fees, you should look critically at your mutual fund's long-term performance to see whether what you're paying is justified. That doesn't mean you should dump your fund the first month or year that it fails to keep up with the broader market or with other funds you own. But if you've held a fund long enough to have gone through an entire market cycle -- typically five years or so -- then a failure to keep up with the index is a sign that you should look elsewhere for investment help.
Source: 401(k) 2012 via Flickr.
5. You can get the same fund, or a similar fund, at a lower cost elsewhere
What many investors don't realize is that the same mutual funds often have different classes with different fee structures. For instance, many funds that charge sales loads to ordinary investors offer no-load shares to participants in employer-sponsored retirement plans like 401(k)s. In those cases, you're essentially getting exactly the same fund exposure -- just without paying fees.
In other cases, you can find similar funds from lower-cost providers that do a better job. For instance, some index-tracking funds still charge huge expense ratios, counting on the ignorance of their shareholders to keep their doors open and that fee income coming in. Only by voting with your feet will you escape their clutches and make the most of your money.
Mutual fund investing is easy and convenient, and it can help you achieve your financial dreams. But make sure you don't pay more than you have to in fees; by saving what you can, you'll leave more money in your pocket for when you need it.
