Mutual Funds Have Fees, But Some Are More Costly Than Others. Here’s How to Find the Right Low-Fee Fund for You

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There are thousands of mutual funds of all shapes and sizes available to invest in. Some are focused on a specific sector, such as technology or energy, while others track an index, such as the aggregate market or S&P 500. But all they all have in common is fees.

When it comes to choosing the best mutual fund for you, the most important thing you can do as an investor is to make sure you understand the costs associated with each fund. There are two broad types of fees that almost all mutual funds charge: shareholder and operating fees. And the amounts they charge can vary, sometimes by huge margins. These fees can gobble up thousands of dollars in profits in the long run, so you want to make sure you know how much you’re paying before you start investing.

But paying fees is worth it, especially low ones. By investing in mutual funds, you are actively creating an investment portfolio that can help you build wealth. Once you understand which costs to look for and which to avoid, you can reap the tremendous benefits of investing.

In this article, we’ll talk about what these costs are and what to look out for, how much is a good amount to pay and why they’re ultimately worth it once you’ve found the right mutual fund for you.

Two Main Types of Mutual Fund Fees

There are two main costs for mutual funds:

Shareholder fees – Commissions and other one-time costs when you buy or sell mutual fund shares, and sometimes exchange them. Operating costs – Ongoing fees charged by a fund for day-to-day fund management.

Both fees are disclosed in a prospectus, the legal document that must be filed with the Securities and Exchange Commission (SEC) that regulates the securities market.

For the most part, you’ll pay higher fees for funds that are actively managed or try to outperform the overall market, but lower fees for passively managed funds that track an index. Actively managed funds tend to have higher costs because there is a team of advisors behind the computer looking to beat the market.

“In recent years they have gone down because of the competition,” says Tanya TaylorFounder & CEO at Increase your wealth† And that’s good news for investors.

Types of Shareholder Fees

While operating fees usually make up the lion’s share of any fees you pay, you should watch out for other fees charged to shareholders.

These are the most common:

Redemption Fee

This is also known as a short-term redemption charge or exit charge. This is what investors pay when shares of the fund are sold before a period specified in the fund’s prospectus, ranging from a few days to more than a year.

This fee is designed to discourage short-term investing and excessive trading, which should not be a problem for long-term investors. It’s a fee paid to the broker, Taylor explains, and can make up about 2% of the total sale.

Exchange rate

If you want to transfer your money to another fund within the same brokerage or fund family, you may see this fee to execute the trade. Some brokers charge this fee while others do not.

Account Fees

This is simply a fee for having and maintaining your account, especially if your balance drops below a certain threshold. It is especially important to note if you have multiple accounts or funds.

Think of it as a minimal maintenance fee like some bank accounts have, Taylor says, but for mutual funds.

Purchase costs:

This is a fee some funds charge when investors buy shares of a mutual fund. It is completely separate from any sales charge or commission paid to the broker to buy a fund.

Loaded and Unloaded Funds

Another shareholder fee to consider is the sales tax.

The tax is a commission paid to the broker when you buy or sell shares of a mutual fund, calculated as a percentage of how much you have invested in the fund. This fee can range from about 3% to 5.75% and is a one-time fee, says Jennifer Webercertified financial planner and vice president, financial planning at Weber Asset Management

You pay this fee at the time of purchase, at the time of sale or on an annual basis, depending on the class of the fund. Class A funds charge a sales tax at the time of purchase, while Class B funds charge it at the time of sale. Class C funds have an annual commission, or may only charge you when you sell the fund. Pay close attention to this fee so that you can expect it when it is charged.

Keep in mind that many mutual funds have no sales or transaction fees at all, which are big selling points. Weber advises clients to “always avoid taxes and invest strictly in untaxed funds that don’t have that commission piece.”

Many excellent funds are no-load funds and great investment choices, so be sure to check this fee, which can always be found in the fund’s prospectus or on the fund’s website.

Fund’s annual operating expenses

Operating fees cover the administrative costs of managing, marketing and selling the fund and are charged as a percentage of the fund’s average net assets. They also cover administrative costs. After all, the brokerage has to cover their business expenses associated with running the fund.

The most common operating costs are:

Management fees – This goes towards the remuneration of fund managers (especially if the fund is actively managed) and advisors. 12b-1 fees – This fee covers the costs of marketing and selling the fund and is capped at 1% per annum (0.75% for distribution and marketing and 0.25% for fund maintenance). Miscellaneous costs – This may include legal, accounting, transfer and other administrative costs.

While management fees are ubiquitous, many funds are cutting back on the 12b-1 fees, Taylor says. It’s usually one of the sneakier fees and Weber doesn’t like to invest in funds that have it. If the cost seems high, it’s worth checking how much the 12b-1 and miscellaneous costs cost.

What is a normal fee for mutual funds?

Mutual fund fees are expressed as a percentage or expense ratio of your total investment. They typically range from 0.5% to 1.5% for actively managed funds and 0.2% for passively managed funds. The important thing to note here is that any fee above 1% is excessive and should be avoided at all costs.

For example, if a mutual fund has an expense ratio of 1%, that means you pay $10 for every $1,000 invested. It doesn’t seem like much, but it gets bigger over time.

Experts advise that less than 0.2% is a good return, and anything higher than 1% can hurt your investment gains in the long run. If you see a fee of more than 1.5%, and certainly more than 2%, know that you can do better. This is why experts recommend passively managed funds, as many funds have fees of 0.2% or lower.

Weber likes mutual funds because “they are a great way to be diversified with a small amount of money and have exposure to the overall market – and you can choose the fund that does that for you. There’s a reason expense ratios exist.”

Pro tip

A good expense ratio for a passively managed mutual fund that tracks an index is 0.2% or less. Anything over 1% is too expensive and you want to stay away.

How are the mutual fund fees charged?

You will not see a bill for fees charged by mutual funds. Instead, they are automatically debited from your account. For this reason, you may not even notice them unless you take the time to look. That’s why it’s worth digging into the fund’s prospectus to discover sneaky fees, especially if it’s not a well-known mutual fund.

Before you start investing, make sure you know the expense ratio. A 1% fee may not sound like much, but over time it will eat up your profits significantly.

As you begin your investment journey, here are NextAdvisor’s best investments for beginners.

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