Mutual fund expenses explained

Q: I want to put some money into a mutual fund but after looking at the company’s web site I’m confused by all of the fees. Can you explain them in laymen’s terms?

A: Mutual Fund companies certainly don’t go out of their way to clarify their expenses. Except for a few companies known for their low expenses, such as Vanguard, most would prefer that you focus on their performance. But fees and expenses can have a significant impact on your total return.

Broadly speaking there are two categories of fund ex­penses, operating expenses and sales charges.

Operating expenses are generally paid out of the fund assets and cover manager and analyst salaries, statement and prospectus printing, call center staff, marketing ex­penses, computer systems, accounting and all of the other myriad costs of running a business. You won’t see these costs directly – they serve to reduce your investment return. For example, if the fund’s investments earned 10% but the fund’s expenses totaled 1.2%, your return would be 8.8%.

Sales charges are commissions paid to the broker that sold you the fund. Funds often have dif­ferent classes of shares that com­prise the same investment pools but differ only in how you pay the commission or “load”. There is no naming standard for these classes, but many companies ad­here to the following designa­tions:

  • Class A shares have a front-end load, which is deducted immed­iately from your investment. So if the load is 5% and you invest $10,000, $500 goes to the salesman and only $9,500 is actually invested.
  • Class B shares have a back-end load, charged when you redeem shares, that typically declines over time. For ex­ample, you may be charged 4% if you redeem within the first year, 3% in the second year and so forth, with no charge after 4 years.
  • Class C shares have a level load, say 1% annually, that never goes away.

Of course, many fund companies do not charge any load. At Mentor we never recommend load funds to our clients, since there are plenty of good no-load funds available.