Whilst the temptation is to go as cheaply as possible, don’t just look at the figures. Many an investor has lost out because he or she opted to go for the cheapest option, and it turned out to be far from the best product to buy. With investment products, you, to a degree, should get what you pay for, but there are many cases in which expensive funds have performed badly, and cheap funds well. This relates to management fees, however, and not to loads, which can be a complete waste of money. For more on this distinction, read on..
There are 3 hidden costs of mutual funds that can cut into your savings more than you may think.
1 – 12b-1 fees
These fees are common in mutual funds and are used to cover marketing and distribution costs. They are clearly listed in the prospectus of every fund. Some fund companies use this fee to pay brokers who bring them custom, so make sure your broker is not offering you a fund for this reason. This fee varies little from fund to fund, so does not significantly impact investor choice.
2 – Loads
Front end loads – A load is a commission paid to a broker when you buy into a mutual fund. This fee goes to the middle man and the middle man only. If you invest $20000 into a mutual fund, and the load is $700, you need to make this just to break even. You will also lose out on some compound interest. In addition to this, loads mean that if you make a bad investment, you can feel trapped. If you want to sell a poorly performing fund, then you will need to buy into a fund in the same family if you want to avoid paying another load. This significantly reduces your options.
Back-end and ongoing loads – Mutual funds are usually listed as A, B and C shares. All of these classes have a load of some kind, cutting into your finances. A shares have a front-end load. B shares have a back-end load. This means that you have to pay at least 5 percent if you sell the funds within 5 to 7 years. C shares have a back-end load which means that if you sell the fund in the first year you pay at least 1 percent.
Quick and simple advice for you: avoid load funds!!! No-load funds are the same and perform just as well, but are much cheaper!
3 – Management fees
These vary considerably for different funds. For example, bond funds have small fees. International equity funds, on the other hand, have large fees, to cover the traveling costs of the fund managers.
Management fees DO vary widely, and this is where you as an investor has the most choice,l and it brings me back to my first point. There is no reason why you should be paying super high management fees if you are not getting the reward, but just going for the lowest fees might leave you with minimal reward anyway. It is important to know how the manager has been running any particular fund, and the returns that he or she has made. If the results are better than the market average, then it would be worth paying a higher than average management fee if this fund demands it.
For more information on mutual funds, go to:
en.wikipedia.org
