No one likes to pay fees, but there's nothing worse than getting hit with a fee that you didn't even know existed. Hidden loads are all too common in the mutual-fund investing world, and they're tacked on as charges in situations where most investors might not necessarily expect them.
Securities laws and regulations typically require funds to disclose the fees they charge, but many such fees end up getting buried in fine print and overlooked by the vast majority of investors. That leaves them lying in wait for unsuspecting investors to trigger their positions so that they end up paying sales charges or other expenses. Below, we'll talk about two common forms of hidden loads and how you can avoid them.
What you don't notice can cost you
Most people are aware of the many fees that mutual funds can charge their investors. Up-front sales loads take a percentage of your initial investment off the top, and the money goes to the person who sells you shares of the mutual fund. Many investors are also aware of the annual expenses that funds incur for their operations, including the costs of paying a professional money-manager to pick investments, as well as the costs of administration and record keeping for accountholders and the transactions they make.
However, most people don't notice two types of fees. The first is the 12b-1 fee, which is a type of sales and marketing charge. Unlike most loads, the 12b-1 fee is imposed on an ongoing basis as a percentage of assets under management. A typical amount for a 12b-1 fee will range from $25 to $100 for every $10,000 you have invested in a fund.
Funds are allowed to use proceeds from 12b-1 fees for sales and marketing costs, and that includes compensating the professionals who sell shares of the fund to you and other investors. Although a small 12b-1 fee might seem preferable to a higher-percentage up-front sales load, the fact that the 12b-1 fee gets charged year after year throughout the lifetime of your account can mean that it ends up exceeding what you'd pay for a load.
The other often-unnoticed fee is the contingent deferred sales charge, or back-end load. These fees only get charged when you sell shares of the mutual fund, but they can end up being as high as, or higher than, the up-front sales loads that other funds charge. With some funds, the longer you own shares, the lower the back-end load will be, and you might not have to pay the fee at all when you exchange your shares for shares of another fund offered by the same manager.
Other funds charge redemption fees, which are similar to back-end loads. With these fees, the proceeds go back to the fund to cover expenses related to your sale of shares.
The best way to avoid hidden loads
Avoiding the hidden-load trap takes the discipline to read fund materials and ask tough questions of the professionals who sell you fund shares. Once you're in the fund, it can be next to impossible to escape without having to pay the fee.
Hidden loads are one reason why some investors are suspicious of mutual fund managers. By knowing in advance that a fund will charge a fee on something most people would overlook, you can make an informed decision about whether choosing another fund might be the better move.
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