Mutual fund fees: what you need to know before investing

A mutual fund is a pooled collection of investment funds. When a person buys shares in a mutual fund, money is combined with other investors’ capital. A professional manager purchases stocks, bonds or other securities on behalf of you and these investors. Because managers must be paid, and fund companies must cover their expenses and turn a profit, all mutual funds have fees — even those touted as “low-cost” or “no-load.”

Some fees are more obvious than others, so you might have to look under the hood to see the total cost of your mutual fund investment.

Here’s a quick look at what you’ll find in this guide to mutual fund fees:

Upfront Sales Charges for Mutual Funds

Some mutual fund companies offer different share classes for the same mutual funds. Shares that carry an upfront sales charge are typically referred to as A-shares. The Financial Industry Regulatory Authority caps upfront mutual fund sales charges at 8.5%. However, funds rarely charge that much.

In fact, over time, the standard upfront sales charge for a mutual fund has dropped from a high of 8.5% in the 1990s down to 3% to 6%, generally speaking, today. Many funds charge no load at all, and those that do typically offer breakpoints.

Breakpoints are better known as discounts for larger purchases. For example, a fund might charge you 5.75% upfront for purchases of $25,000 or less, 3.50% if you buy between $100,000 and $250,000, and nothing at all for investments of at least $1 million.  

An upfront sales charge reduces the amount that you get to invest. For example, if you’re investing $10,000 into an A-share mutual fund, only $9,900 or less might actually get put to work for you. The excess $100 goes right into the pocket of your financial advisor or the mutual fund company.

Contingent Deferred Sales Charges for Mutual Funds

The term “contingent deferred sales charge” is a fancy way of saying you’ll pay a fee if you sell shares of your mutual fund. You typically won’t pay a CDSC if you sell Class A shares of a mutual fund, but you might if you sell Class B or Class C shares. Class B shares typically charge a sales fee that declines the longer you hold the fund.

For example, if you sell B shares in the first year after you bought them, you might face a 5% sales charge. In the second year, the charge might decline to 4%, followed by 3% in year three, 2% in year four and 1% in year five. After a certain number of years, such as eight, B shares automatically convert to A shares, which charge lower ongoing expenses.

Class B shares put all of your money to work right away; however, they do reduce your investment flexibility. Although most mutual fund companies allow you to make free exchanges to other funds within the same family, you can’t sell your MFS fund and buy a Vanguard fund, for example, without triggering the redemption fee.

With C shares, you don’t pay an upfront sales charge, and your CDSC is typically low, such as 1%. C shares usually only charge a CDSC on redemptions made in the first year after purchase. But they never convert to A shares, and they carry higher ongoing expenses.

A C-share investment is something of a hybrid compromise. You don’t lose any money at the time of investment. Plus, after a relatively short time frame, you have the flexibility to change your investment as well. If you hold the shares for a long time, however, you’ll end up paying a higher overall expense.

Mutual Fund Expense Ratios

A mutual fund expense ratio is the percentage of your fund investment that a fund company deducts annually to cover various expenses. Services covered by the expense ratio typically include the following: 

  • Portfolio management
  • Fund administration and compliance
  • Shareholder services
  • Recordkeeping
  • Distribution charges, known as 12b-1 fees
  • Other operating costs

Fund expense ratios vary based on a number of factors, ranging from the number of assets in the fund to the fund’s investment objective. On average, larger funds charge smaller expense ratios, and equity funds have higher fees than bonds or money market funds.

How Are Mutual Fund Fees Calculated?

Mutual fund fees are computed by multiplying the sales charge by your invested assets. For sales charges, the computation is (sales charge percentage x assets invested). For example, if you invest $10,000 into an A-share mutual fund charging a 5% fee, you’ll pay (0.05 x $10,000), or $500. This charge goes directly to the mutual fund company.

For annual expenses, the formula is (expense ratio x invested capital). Thus, a fund with a 1% expense ratio will charge $1 for every $100 you have invested in the fund. This money is taken out of your invested funds automatically on an ongoing basis.

What Is the Average Fee for Mutual Funds?

Over time, expense ratios for most funds have come down. In 1997, for example, the expense ratio for the average equity mutual fund was 99%. By 2020, that had tumbled all the way down to 0.50%. Similarly, bond fund expense ratios fell from an average of 0.82% to 0.42% over the same time period.

Other Mutual Fund Fees

Expense ratios don’t cover the commission and trading costs that a fund incurs when buying or selling securities. Those costs are subtracted from a mutual fund’s annual return. A fund that engages in excessive trading, as measured by its turnover rate, may have higher costs that aren’t found in the expense ratio.

Other mutual fund fees might include:

  • Account fees for establishing an account
  • Maintenance fees, if your account value falls below a certain level
  • Short-term redemption fees, if you sell shares within a specified number of days after purchase
  • Exchange fees, for moving your money to another fund
  • Purchase fees, or costs on top of sales charges for buying a fund

Are Mutual Funds Safe?

All investments bear some risk. As mutual funds come in many styles, some are riskier than others in terms of volatility. However, other, less-obvious risks affect different types of funds as well. Bond funds, for example, carry interest rate risk and inflation risk, among others, whereas international funds carry foreign currency risk.

Overall, mutual funds can help reduce risk in a portfolio because they traditionally invest in diversified portfolios. However, each fund still carries risk, and these risks should be outlined in the fund’s prospectus.

How Do I Choose a Mutual Fund?

To choose a mutual fund, you must incorporate a number of different factors. Certainly, cost should be one of the most important considerations; however, your investment objectives and risk tolerance are equally important.

All other things being equal, you’ll want to choose the fund with the lowest combination of upfront and ongoing expenses. However, if you’re looking for a high-risk, high-growth fund, it makes no sense to buy a low-cost government bond fund. First, match your investment style with a fund. Then, look to make the lowest-cost choice.

Mutual Funds Have Ongoing Costs

When you purchase a stock, you usually pay a commission to buy and sell and incur no additional costs.

In addition to fees to purchase and sell shares, mutual funds also have ongoing costs to investors. You might have to read the fund prospectus to find a complete list of costs, as they are not all immediately apparent. Although fees generally have fallen across the board, when it comes to investing in mutual funds, there’s no such thing as a free lunch.

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