Costs are important because they lower your returns. A fund that has a sales load and high expenses will have to perform better than a low-cost fund, just to stay even with the low-cost fund.
Find the fee table near the front of the fund's prospectus, where the fund's costs are laid out. You can use the fee table to compare the costs of different funds.
The fee table breaks costs into two main categories:
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sales loads and transaction fees (paid when you buy, sell, or exchange your shares), and
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ongoing expenses (paid while you remain invested in the fund).
Sales Loads
The first part of the fee table will tell you if the fund charges any sales loads.
No-load funds do not charge sales loads. When you buy no-load funds, you make your own choices, without the assistance of a financial professional. There are no-load funds in every major fund category. Even no-load funds have ongoing expenses, however, such as management fees.
When a mutual fund charges a sales load, it usually pays for commissions to people who sell the fund's shares to you, as well as other marketing costs. Sales loads buy you a broker's services and advice; they do not assure superior performance. In fact, funds that charge sales loads have not performed better on average (ignoring the loads) than those that do not charge sales loads.
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Terms To Know
Front-end load: A front-end load is a sales charge you pay when you buy shares. This type of load, which by law cannot be higher than 8.5% of your investment, reduces the amount of your investment in the fund.
Example: If you have $1,000 to invest in a mutual fund with a 5% front-end load, $50 will go to pay the sales charge, and $950 will be invested in the fund.
Back-end load: A back-end load (also called a deferred load) is a sales charge you pay when you sell your shares. It usually starts out at 5% or 6% for the first year and gets smaller each year after that until it reaches zero (say, in year six or seven of your investment).
Example: You invest $1,000 in a mutual fund with a 6% back-end load that decreases to zero in the seventh year. Let's assume for the purpose of this example that the value of your investment remains at $1,000 for seven years. If you sell your shares during the first year, you only will get back $940 (ignoring any gains or losses). $60 will go to pay the sales charge. If you sell your shares during the seventh year, you will get back $1,000.
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Ongoing Expenses
The second part of the fee table tells you the kinds of ongoing expenses you will pay while you remain invested in the fund. The table shows expenses as a percentage of the fund's assets, generally for the most recent fiscal year. Here, the table will tell you the management fee (which pays for managing the fund's portfolio), along with any other fees and expenses.
High expenses do not assure superior performance. Higher expense funds do not, on average, perform better than lower expense funds. But there may be circumstances in which you decide it is appropriate for you to pay higher expenses. For example, you can expect to pay higher expenses for certain types of funds that require extra work by its managers, such as international stock funds, which require sophisticated research. You may also pay higher expenses for funds that provide special services, like toll-free telephone numbers, check-writing and automatic investment programs.
A difference in expenses that may look small to you can make a big difference in the value of your investment over time.
Example: Say you invest $1,000 in a fund. Let's assume for the purpose of this example that you receive a flat rate of return of 5% before expenses. If the fund has expenses of 1.5%, after 20 years you would end up with roughly $1,990. If the fund has expenses of 0.5%, you would end up with more than $2,410. This is a 22% difference.
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Terms To Know
Rule 12b-1 fee: One type of ongoing fee that is taken out of fund assets has come to be known as a rule 12b-1 fee. It most often is used to pay commissions to brokers and other salespersons, and occasionally to pay for advertising and other costs of promoting the fund to investors. It usually is between 0.25% and 1.00% of assets annually.
Funds with back-end loads usually have higher rule 12b-1 fees. If you are considering whether to pay a front-end load or a back- end load, think about how long you plan to stay in a fund. If you plan to stay in for six years or more, a front-end load may cost less than a back-end load. Even if your back-end load has fallen to zero, over time you could pay more in rule 12b-1 fees than if you paid a front-end load.
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Tips for Comparing Costs
- Beware of a salesperson who tells you, "This is just like a no-load fund." Even if there is no front-end load, check the fee table in the prospectus to see what other loads or fees you may have to pay.
- Check the fee table to see if any part of a fund's fees or expenses has been waived. If so, the fees and expenses may increase suddenly when the waiver ends (the part of the prospectus after the fee table will tell you by how much).
- Many funds allow you to exchange your shares for shares of another fund managed by the same adviser. The first part of the fee table will tell you if there is any exchange fee.
Other Sources of Information
Read the sections of the prospectus that discuss the risks, investment goals, and investment policies of any fund that you are considering. Funds of the same type can have significantly different risks, objectives and policies
All mutual funds must prepare a Statement of Additional Information (SAI, also called Part B of the prospectus). It explains a fund's operations in greater detail than the prospectus. If you ask, the fund must send you an SAI.
You can get a clearer picture of a fund's investment goals and policies by reading its annual and semi-annual reports to shareholders. If you ask, the fund will send you these reports.
You can also research funds at most libraries. Helpful resources include fund investment books, investor magazines and newspapers. The fund companies themselves can also provide information.