A personal finance blog dedicated discussing such topics as budgeting, asset allocation, 401K, IRA, cash flow, insurance, financial planning, portfolio management, and other areas in personal finance.


Tuesday, July 19, 2005

Understanding Mutual Funds Fees

With so many mutual funds available and so many different ways to buy them, it is important to understand the different ways fees are charged.

Basically, there are two types of mutual funds: Load and No-Load.

No-Load funds (full-service brokers are notorious for calling them "no-help" funds) are funds that investors buy for themselves either through a discount brokerage or directly through the mutual fund company. There are no up front charges or loads to get into these funds although there may be transaction fees if bought through a broker.

Load funds are funds in which there is a charge associated with investing in the fund. To complicate matters, there are different types of loads (A,B, and C are the most common).

A Shares

An A-share mutual fund charges the load up front. The typcial front-load starts at 5.75% and decreases for larger investments. An investment of $10,000 in an A share mutual fund with a front-load of 5.75%, will result in a $575 load. That means only $9,425 goes to work right away. In addition, there are annual management fees, which I will talk about later.

B Shares

B-share mutual funds are quite controversial. A B-share mutual fund does not charge an up front load. Instead, there are contingent deferred sales charges that will be deducted from the account if the investor decides to sell the mutual fund before a certain number of years (usually around 6 years) has passed. In addition to the deferred sales charges, the mutual fund will charge additional management fees of around 1% per year during the deferred period to recoup the broker's commissions.

The reason B-shares are controversial is that some brokers were telling people that B-Share mutual funds were no-load mutual funds. There have also been instances in which the broker used B-shares in order to avoid breakpoints associated with A-shares. I have a hunch that we will see B-shares outlawed.

C Shares

The third most popular type of load is the C-Share. C-Share mutual funds do not charge front-loads but instead charge a higher management fee (usually 1%) each year. This 1% fee goes to the broker in charge of the account. Although in the long-run C-Shares are more expensive than A-shares, the broker's and the client's interests are more aligned since the broker has an interest in the client's success.

Management Expenses

All load and no-load funds have management fees. A common misconception is that no-load funds are cheaper than load funds. This may not always be the case. American Funds is a load fund family that has rock bottom management fees. Over the long-run, their funds would be cheaper to own than a lot of no-load mutual funds.

Management fees are usually broken down into the following categories:
  • Management fees

  • Distribution or Marketing (12b-1) fees

  • Other fees
The other category includes custodial, legal, transfer and other fees.

I hope that helps explain the different types of fees. In a future post I will talk about how to compare fees of different mutual funds.

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