The ABC's of Mutual Fund Fee's

Posted By: Advisor Analyzer Team

Mutual funds, and more specifically load bearing funds, are some of the most widely held investment positions in the average investor’s portfolio today.   They dominate the investment holdings of many IRA’s and other portfolios.  While the variety of funds available is virtually endless, they all share some very common themes: the way they charge investors for their services.

 

Mutual funds can be a godsend for some investors: they transform the research, execution, and overall portfolio management responsibilities of investing into a simple one step procedure.  Anyone who’s ever read through a dozen 10-Q’s know the analysis can be a both monotonous and confusing task.  Why waste countless hours pulling out your hair by the roots, when the pro’s can cover a wider number of investments faster and more accurately?  It seems like a foolproof method to invest.

 

While they can be a great long term investment vehicles, investors should be very cautious of the different fees that are charged for the hired expertise.  Open end funds have sales, administrative, management, and sometimes redemption fees.  The type of mutual fund position can have a significant impact on your willingness to liquidate the position.  Let me explain this whole fee business to those unfamiliar to the structure.

The ABC’s of Fees

The sales charge, is a commission that Is paid to the financial advisor or broker who introduces the investment.  If they are charged upon liquidation, they are called back end loads, and if they are paid upon purchase, they are front end sales charges.  Aside from the introducing broker’s cut, investors must pay fees to the investment company that is actually managing the investor’s funds for administration and reporting annually. 

 

Some investors choose to pay the full charge at the time of purchase, by investing in A-shares.  A-shares allow investors to redeem (sell) their fund at any time without penalty and often have lower administration and management fees.  So if I were to purchase $100 worth of ABCAE, (note: the forth letter in a open end fund usually denotes its share-class) I would pay $4 up front, and have the $95 invested in the market.  At the end of the year, I will also pay $1 dollar in management and administration fees, which must be paid annually.  So, if the markets went nowhere and I decided to sell, I am left with say $95.

Others may choose to avoid paying the $4 upfront by purchasing B-shares.  Investors of B-shares pay no sales charge upfront and fairly low management and administration fees.  So where’s the catch?  Around the corner at the back end.  B-shares have large redemption fees, so investors have to pay a severe penalty for experiencing buyer’s remorse.  The redemption fees don’t last forever, usually 5-7 years and they gradually decrease as time passes.  So if I instead used the $100 to purchase the ABCBE fund (note the “B”), I pay $1 for management and administration at the end of the year.  If I decided to sell in the first year, I would have to pay $7, the second year I pay $6 to sell, and $5, $4, $3, $2, $1, $0 after seven years.  So after seven years, I do not have to worry about the sales or redemption charges, however the $1 is still paid every year.

 

Investors who’d like to avoid both the sales charge and redemption fees can choose to purchase C-shares.  C-shares are structured so investors pay no upfront fees, and after a year or so, no redemption fees as well. Sounds pretty reasonable so far right?  However, there are hefty annual administrative and management fees.  After all, they have to put food on their tables too; this isn’t a charity they’re running right?  Someone who invests $100 in the ABCCE fund and held it over a year can sell it without penalties, but may pay $2-3 dollars annually. 

Conclusion

While there are many more open end fund share classes, these three are the most popular holdings of investors.  Like any investment, there are both costs and benefits, and it is up to the investor to determine the most suitable tradeoff.  They take a majority of the guess work away from the average Joe, but the fees associated with such positions can inhibit the investor’s desire to exit the position early.  Therefore, open end funds should be viewed as long term investment vehicles due to the penalties for early withdrawal.  For those who capriciously trade in and out of positions, open end funds are definitely not the investment of choice.