Jane M. Young, CFP, EA
When investing in mutual funds it is important to be aware of the associated fees. High fees can significantly impact your total investment return. All mutual funds have operating expenses and some have sales fees, commonly known as a load. When you invest in mutual funds you have a choice between load and no-load funds. A mutual fund load is basically a commission charged to the investor to compensate the broker or sales person. As the name implies, no-load funds do not charge a sales fee.
The first type of load fund is an A share fund, where you pay a front end sales charge plus a small annual 12b-1 fee. A 12b-1 fee is a distribution fee that covers marketing, advertising and distribution costs. The typical front-end load is around 5%, but can go as high as 8.5%. Class A shares offer breakpoints that provide you with a discount on the sales load when you purchase larger quantities or commit to making regular purchases. The 12b-1 fee associated with most A shares is generally about .25% annually.
The second type of load fund is a B share, where you pay an annual fee of around 1% plus a contingent deferred sales charge (CDSC), if you sell before a specified date. The CDSC usually begins with a fee of 5% that gradually decreases over five years. After five years or so the fund converts to an A share fund. The actual percentages and timeframes may vary between fund families. Most mutual fund companies have stopped offering B share funds because they are usually the most expensive option for the investor and the least profitable option for the mutual fund company.
The third type of load fund is a C share that charges a level annual load, usually around 1%. This is on-going fee that is deducted from the mutual fund assets on an annual basis.
Generally, any given mutual fund can offer more than one share class to investors. There is no difference in the underlying fund. The only difference is in the fees and expenses that the investor pays.
All load and no-load mutual funds charge fees associated with the operation of the fund. The most significant of these expenses is usually the management fee which pays for the actual management of the portfolio. Other operations related fees may include administrative expenses, transaction fees, custody expenses, legal expenses, transfer agent fees, and 12b-1 fees.
These annual fees are combined and calculated as a percentage of fund assets to arrive at the fund’s expense ratio. The expense ratio is an annualized fee charged to all shareholders. The expense ratio includes the fund’s operating expenses, management fees, on-going asset based loads(C shares) and 12b-1 fees. The expense ratio does not include front-end loads and CDSCs. According to Morningstar the average mutual fund expense ratio is .75%.