Please ensure Javascript is enabled for purposes of website accessibility

Index Funds’ "Hidden Fees"

By Motley Fool Staff – Updated Oct 14, 2016 at 12:03AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Index funds are known for being inexpensive, but hidden purchase and redemption fees can cost investors thousands of dollars.

Vanguard manages more than $3.5 trillion of investor capital, far more than other asset managers because its funds are some of the least expensive on the market today. But not all fund fees are as obvious as they may seem, and buying an index fund is more complicated than it may appear.

In this clip from Industry Focus: FinancialsThe Motley Fool's Gaby Lapera and Jordan Wathen discuss the costs of owning an index fund, some fees you should try to avoid, and the difference in index fund strategies.

A full transcript follows the video.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

This podcast was recorded on Sept. 14, 2016.

Gaby Lapera: Let's get to the nitty-gritty of actually buying one. There are fees involved in buying an index fund. We mentioned the commission, if you're buying an ETF, but that's the same as if you're buying any other stock. There's also purchase and redemption fees. Can you get a little bit into those for me, Jordan?

Jordan Wathen: In the past, there used to be these fees called loads, and they've gone by the wayside. Basically, what a load was was an upfront fee, and sometimes a back-end fee that you would pay to buy or sell a mutual fund. Eventually, people figured out that paying 3% just to buy a mutual fund was a bad idea, and luckily, the world is changing and people are becoming more cognizant of cost, so they're going away. But purchase and redemption fees still exist. You just want to be really aware, really cognizant of the fact that there can be purchase and redemption fees on some funds. Even Vanguard, which is known for keeping costs as low as possible, charges some purchase and redemption fees on some of its bond index funds, for example.

Lapera: Yeah. What you would be looking for in the text -- because whenever you buy an index fund, you can go online and the companies are required to provide you a lot of information about them. Or if you really want to, you can ask for a paper copy of this. But there should be something that says load or no load, and you're going to be looking for a no load fund.

Wathen: Right. Even no load funds can have purchase and redemption fees.

Lapera: ... and those will also be listed as well. So make sure to look at that. And the other thing that we touched on earlier is expense ratios. If you happen to be buying it as a mutual fund instead of as an ETF, you want to see how much the expense ratio is. It still matters for the ETF, but a little bit less.

Wathen: Basically, what that does -- to give an explanation -- the expense ratio is the cost of holding that fund over a year divided by how much you've invested in. If you have $1,000 to invest, and the fund charges 0.5% to invest in it, you'd basically be paying $5 per year on that amount.

Lapera: Right. That's a really big thing you should check before you actually buy the fund, what fees are involved. Just to refresh, again, just in case, for whatever reason, you missed it -- it's purchase and redemption fees, whether or not it has a load, and the expense ratio. 

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.