Mutual Fund Fees and Expenses
Just as important as the information on investment objective, strategies, and risks is the information describing the mutual fund’s fees and expenses.
Mutual funds may issue different share classes with different fees. “A” shares, “B” shares, and “C” shares, which are generally sold by retail brokers to individual investors, have the highest fees and expenses. “I” shares, “K” shares and “R” shares, which typically are sold at quantity discounts to retirement plans and large institutional investors, have the lowest fees and expenses.
This information will be listed in what is known as a fee table.
The fee table is divided into two sections: shareholder expenses, and the annual operating expenses. The fee amounts shown are expressed as a percentage of the amount of the investment. With few exceptions, the total percentage that a shareholder pays depends almost entirely on the amount of their investment. The higher the investment, the lower the percentage.
The Sales Load v. the Redemption Fee
The two most common shareholder expenses are the sales load and the redemption fee, which are paid to compensate the broker for selling the mutual fund. The sales load is the on-time commission paid by the investor to the selling broker. These shares are commonly referred to as “A” shares. The sales load on these shares, which are sold in smaller amounts to individual retail investors, can range from 2% to 6.25%.
The redemption fee is also known as a contingent deferred sales charge, so named because the investor pays it only if they exit the mutual fund before the expiration of the agreed upon holding period. In this arrangement, the investor does not pay an up-front sales load. Instead, a mutual fund distributor (usually related to the investment adviser) advances the sales load to the selling broker and the investor pays it back to the mutual distributor over time (see distribution fees below). Shares with redemption fee features are commonly referred to as “B” shares.
The investor who redeems before the mutual fund distributor has recouped their advancement pays a redemption fee. Investors who hold their investment for the sufficient time will not pay a redemption fee. Therefore, avoid unpleasant surprise by understanding the amount of the redemption fee and the duration of the holding period.
Other Categories of Fees
The annual operating expenses are ongoing recurring fees that mutual fund shareholders pay and are allocated to three categories:
- The management fees are the fees paid to the investment adviser for managing the mutual fund’s assets.
- The distribution and/or service (12b-1) fees are also known as trailing commissions. These are paid over time to mutual fund distributors and selling brokers in lieu of an up-front sales load. Service fees are paid to service providers to provide ongoing shareholder or record-keeping services to the shareholder. 12b-1 refers to the SEC rule that permits the mutual fund to charge the investor this type of trailing fee. Shares with distribution fees are known as “B” shares and “C” shares.
- Other expenses are a catch-all category that can include, among other things, fees for the custodian, transfer agent, the board of directors, and compliance with federal laws and regulations.
Fees and expenses will adversely affect a mutual fund’s investment performance. Over time, an annual fee as low as 0.25% can cost investors tens of thousands of dollars in investment performance. So, it is important to understand what you are paying and why.
Next: In part 3, we will discuss the prospectus.
Charles Field is Managing Partner of the San Diego office of Sanford Heisler Sharp and Chair of the firm’s Financial Services Litigation Practice Group.