Having a diversified investment portfolio is a smart strategy no matter your age. One good way to diversify is to invest in mutual funds. Rather than agonizing over whether your portfolio contains just the right mix of stocks and bonds, you can pay a mutual fund manager to decide how to allocate your capital. However, that expert investment strategy comes at a cost, as you'll need to pay fees to keep your money invested -- fees that can eat away at your profit.

That's why so many investors seek out capped mutual funds, which limit the fees they can charge their shareholders each year. Since the goal of investing in mutual funds is to generate the highest possible return while paying the lowest possible fees, capped funds offer the advantage of a fee ceiling that investors can factor into their investment decisions.

Fees

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Why mutual funds charge fees

Just as running a business takes money, so too does running a mutual fund. Mutual funds need to charge fees to cover all sorts of operating expenses, and those expenses can vary depending on the type of fund in question. Typically, a mutual fund's largest expense is the fee paid to its investment manager or advisor, but there are other costs that need to be covered as well, such as record-keeping, transaction and brokerage fees, legal expenses, marketing, and accounting and auditing fees. These costs, in turn, are passed on to investors.

Investors naturally prefer mutual funds with relatively low expense ratios. (The expense ratio is the percentage of assets under management that a fund costs to operate, and thus it represents the fee investors must pay to invest in the fund.) The benefit of a capped fund is that investors know exactly what sort of fees they'll be paying up front.

Capped funds versus non-capped funds

Capped funds place limits on the annual fees they can charge investors. Non-capped funds have no such limits, and they will charge whatever is necessary to cover their expenses. Keep in mind, however, that a capped fund's manager can raise or remove the cap. A capped fund's prospectus will generally reveal when the fund's expense limit will change or expire.

While you might assume that it's always better to choose a capped fund over a non-capped fund, this isn't necessarily the case. There are other factors to consider when choosing a mutual fund, such as performance history and investment strategy. For example, if Fund A charges 0.3% more than Fund B but has historically outperformed Fund B by 2% per year, then Fund A looks like the better choice.

It's important to look at the big picture when deciding which mutual fund is right for you. 

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