Have you ever looked through your cable bill to see how much you were paying for the extra-fast internet speed? What about the monthly statements from your credit card, bank and utility companies, just to make sure nothing is amiss?
Your investment accounts deserve at least as much scrutiny as bills from your other service providers — and probably much more, given the number of dollars on the line. But unlike other bills where fees are spelled out clearly, it takes a bit of work to suss out exactly what you’re being charged by the companies that manage your investments. And to figure out if you’re paying too much.
There are costly consequences to ignoring the impact of fees on your investments.
Mutual funds are the primary way Americans invest in the stock market. Of course, you can expect to pay something to the folks who keep your investments on track. The fees fall mainly under a wide umbrella of “management fees.” Unfortunately, they are not spelled out that clearly on your account statements.
Mutual fund management fees go by all sorts of names, including expense ratios, 12b-1 fees, sales loads, back-end and front-end loads, contingent deferred sales loads, distribution fees, redemption fees, exchange fees, TERs (total expense ratios) … you get the gist.
In a separate article we wrote about the mutual fund management fees to watch out for and why. (Spoiler: There are costly consequences to ignoring the impact of fees on your investments.) Here are a handful of other important things to know:
1. You don’t get what you pay more for
Research has shown time and again that mutual funds with high fees do not outperform their lower-fee peers. This holds across different investment categories and various time periods. In fact, when you compare the returns of low-fee and a higher-fee funds, the performance difference is nearly identical to the amount charged in fees. Bottom line: Lower expenses mean higher returns.
2. The type, size and strategy of a mutual fund affects fees
In general, bigger is cheaper. Large-cap funds (ones that invest in large companies) have lower average management expenses than small-cap funds (1.25% versus 1.4%, according to Investopedia). Same with funds that have lots of investment dollars versus smaller funds. A mutual fund’s investment objective can also affect expenses. If it requires more frequent trading or rebalancing, or overseas travel to keep an eye on the global marketplace, that means more dollars spent on manpower to manage the fund. Simpler is cheaper. That’s why index mutual funds have the lowest expense ratios — they simply hold the stocks that are part of the benchmark index.
3. 1.5% is too high of a price to pay
Expense ratios on both actively managed mutual funds and index mutual funds have come down in recent years. According to Investment Company Institute data, the average expense ratio for actively-managed funds (ones that employ a team of stock analysts to steer the ship) is 0.74%, or 74 cents for every $100 invested. However, these fees can go as high as 2.5%. The average expense ratio for index funds is 0.07% (or 7 cents for every $100 invested). The only reason to pay more than a fraction of a percentage in fees is if the mutual fund fills an essential role for your diversification strategy and there’s no lower-fee option.
4. Don’t assume all index funds are “cheap”
Index mutual funds are known for the low cost of ownership. That’s because they don’t require a team of investment managers to actively make stock picks. That said, not all index funds are created equal. Lots of financial firms offer index funds and some tack on higher fees, perhaps hoping that investors won’t notice. It pays to comparison shop. FINRA’s Fund Analyzer makes it easy to do.
5. Beware of “no-load” funds that charge load-like fees
The word “load” means sales charge in the land of mutual funds. However, there are rules that permit mutual funds to charge fees that, in practice, mimic the sales loads discussed above and still call themselves “no-load” funds. They might be called redemption fees, exchange fees or purchase fees. The “no-load” label simply means that those fees do not exceed 0.25% of a fund’s average annual net assets. You’ll have to more closely examine a mutual fund’s prospectus to find out what it charges in fees.
The real-dollar cost of mutual fund management fees
A 1% difference in mutual fund management fees may not seem like something to fuss about. But over time — and as your portfolio grows — it adds up. A $100,000 portfolio earning 4% in average annual returns will be worth $219,000 in 20 years. Paying a 0.5% expense ratio costs you $15,000. But a 1.5% mutual fund management fee leaves you with $46,000 less.
The bottom line is that it pays to review your investment account statements — specifically the paperwork that tells you what you’re paying to own a mutual fund. You’ll find all the information spelled out in the mutual fund prospectus, or use a mutual fund analyzer that calculates the costs of ownership for you.
MORE FROM HERMONEY:
- The Triple Threat To Your Investment Returns: These Fees
- This May Be the Only Mutual Fund You Ever Need to Own
- Your Portfolio Is Out of Whack. Here’s How to Rebalance It