Mutual Funds Letters

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If you have a solid record of picking stocks, the thought of starting your own mutual fund may have crossed your mind at some point. Technically, anyone who meets the regulatory requirements and is willing to pay the start-up costs can create a mutual fund. Whether it's a good idea is another matter.

Regulatory requirements
The Security and Exchange Commission requires that all mutual fund managers be registered investment advisors, and each state has its own regulatory laws governing mutual fund managers. The paperwork can be complex, so you'll probably need legal help to make sure you get it right, but the process of creating a mutual fund isn't as complicated as you might think.

There are even companies that specialize in helping advisors create their own mutual funds, and they will handle all of the start-up procedures for you (for a fee, of course). To use these services, you'll generally need to submit a business plan and prove that you have the potential to be successful to create your fund.

The costs can be prohibitive
Not only are the start-up costs prohibitively expensive, but the ongoing expenses of running a mutual fund are also more than many people think.

As far as start-up costs go, you'll need to pay to register in each state you'd like the ability to do business in, register each class of shares you'll offer, create a new investment trust or add your new fund to an existing one, pay for the costs of printing your prospectus, and pay legal fees, just to name the major expenses. Estimates for initial setup costs vary from $25,000 to upwards of $100,000, depending on the nature of your mutual fund and who sets it up.

The costs on an ongoing basis can make it difficult for new mutual funds to turn a profit. According to mutual fund service company Premier Fund Solutions, a mutual fund with $10 million in assets can expect about $139,662 in annual operating costs for 2016. If you charge investors a 1.5% expense ratio, you'll bring in $150,000 in revenue -- a profit of just over $10,000 after expenses.

It is important to note, however, that as a fund grows in assets, its profitability can increase dramatically since the costs will rise at a slower rate than the money flowing in. For example, Premier Fund Solutions estimates that a fund with $15 million in assets would produce an after-expense profit of more than $85,000, 750% more than a fund with $10 million.

The bottom line is that while any registered investment advisor has the ability to create a mutual fund, it may not be in that person's best interest to do so, unless there is good reason to believe the fund will attract enough investors to produce a solid after-expense profit.

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