Do you know how much you’re paying for the actively managed mutual funds in your portfolio?
If you’re being honest, the answer is probably something like “not exactly.” That’s because mutual funds don’t always make their fees easy to understand, despite regulations requiring basic transparency from fund managers and issuers.
“My clients often ask me for plain-English explanations of the mutual fund and money management fees they see on their statements,” says San Francisco-based wealth manager Daniella Rand. “I don’t blame them. For those not steeped in money management, it’s a lot to keep track of.” “I also find that the transparency of customer statements varies widely from firm to firm,” Rand continues. “That is why The Rand Group has always spent as many hours as it takes to educate clients on what they are paying while making sure they are comfortable. We’ve had far less questions since migrating our clients to Merrill Lynch, thanks to their #1 ranked statement industry-wide,” says Rand.
Rand relies exclusively on “best in class” funds and money-managers to build custom portfolios for her clients, and she makes a point of educating prospective clients about the true cost of their existing investments. She’s not alone; many reputable wealth managers prize transparency and see their roles as, at least in part, educational and explanatory.
Want to know more about how your mutual funds make money? Here’s the skinny on calculating and reducing mutual fund fees.
Load fees come in several forms:
- Front-end loads, taken when investors purchase shares in the fund
- Back-end loads, taken when investors sell shares in the fund
- Constant or level loads, taken at regular intervals during the investor’s hold period
Not all funds charge load fees. Funds that don’t charge loads are known as no-load funds; ask your financial advisor which type is suitable for your needs.
All mutual funds charge management fees, which are the most common (and usually largest) component of the expense ratio. The management fee covers the cost of the fund’s management — literally, its managers’ salaries. A given fund’s exact management fee is a function of how actively managed it is; funds that require constant attention carry higher fees than passively managed funds designed to mirror the performance of a benchmark index.
The 12b-1 fee is the most interesting, and most misunderstood, type of fee in the mutual fund universe. This fee covers the cost of marketing the fund to new investors. Although it’s part of the expense ratio, federal regulation requires its inclusion in the fund prospectus; fund managers can’t conceal it by folding it into the management fee.
It’s worth noting that many mutual fund managers see 12b-1 fees as counterproductive or even harmful to investors’ financial interests, although this is far from a universally shared view and many advisors make compelling cases for the fee’s inclusion in the expense ratio. Still, a significant minority of mutual funds don’t charge 12b-1 fees.
Building a Better Investment Portfolio
Mutual fund managers are no longer free to set whatever price they wish and expect investors to happily pony up. By and large, today’s wealth management clients are far more sophisticated than that. We’re operating in a fee- and expense-conscious environment, and that’s largely a good thing.
By the same token, wealth management clients shouldn’t automatically assume that lower-cost mutual funds or money managers are superior to more expensive alternatives. Yes, it’s true that fees can reduce investment returns over time, but fees aren’t the only determinant of fund performance. In many cases, it makes sense to pay more for higher-quality instruments poised to grow faster than their fees can keep pace.
Of course, these considerations are best discussed with your financial advisory team. Just as no two fund managers are exactly alike, and no two funds contain precisely the same component mix, no two investors are identical. You owe it to yourself to build a better investment portfolio that works for you and no one else.