A mutual fund will classify expenses into either annual operating fees or shareholder fees. Annual fund operating fees are an annual percentage of the funds under management, usually ranging from 1-3%. Annual operating fees are collectively known as the expense ratio. A fund’s expense ratio is the summation of the advisory or management fee and its administrative costs.
Shareholder fees, which come in the form of sales charges, commissions and redemption fees, are paid directly by investors when purchasing or selling the funds. Sales charges or commissions are known as “the load” of a mutual fund. When a mutual fund has a front-end load, fees are assessed when shares are purchased. For a back-end load, mutual fund fees are assessed when an investor sells his shares.
Sometimes, however, an investment company offers a no-load mutual fund, which doesn’t carry any commission or sales charge. These funds are distributed directly by an investment company rather than through a secondary party.
Some funds also charge fees and penalties for early withdrawals or selling the holding before a specific time has elapsed. Also, the rise of exchange-traded funds, which have much lower fees thanks to their passive management structure, have been giving mutual funds considerable competition for investors’ dollars. Articles in the financial media about how fund expense ratios and loads can eat into rates of return have also stirred negative feelings about mutual funds.
Classes of Mutual Fund Shares
Mutual fund shares come in several classes. Their differences reflect the number and size of fees associated with them.
Currently, most individual investors purchase mutual funds with A shares through a broker. This purchase includes a front-end load of up to 5% or more, plus management fees and ongoing fees for distributions, also known as 12b-1 fees. To top it off, loads on A shares vary quite a bit, which can create a conflict of interest. Financial advisors selling these products may encourage clients to buy higher-load offerings to bring in bigger commissions for themselves. With front-end funds, the investor pays these expenses as they buy into the fund.
To remedy these problems and meet fiduciary-rule standards investment companies have started designating new share classes, including “level load” C shares, which generally don’t have a front-end load but carry a 1% 12b-1 annual distribution fee.
Funds that charge management and other fees when an investor sell their holdings are classified as Class B shares.
Mutual funds are subject to industry regulation that ensures accountability and fairness to investors.
- Minimal investment requirements
- Professional management
- Variety of offerings
- High fees, commissions, other expenses
- Large cash presence in portfolios
- No FDIC coverage
- Difficulty in comparing funds
- Lack of transparency in holdings