A mutual fund's expense ratio is defined as the percentage of a fund's assets that are deducted from earnings every year to cover the operating expenses of that fund. Mutual fund fees include any extra costs charged to own that particular investment, such as front-end or back-end loads. Understanding exactly what mutual fund fees and expenses mean to an investment portfolio is essential to being successful in the stock market.
The Average Mutual Fund Expense Ratio
According to New York-based Lipper Inc. the average expense ratio of an actively managed fund was .712% in 2008. For equity funds the average was slightly higher at about 0.94%, while passively managed index funds had an average expense ratio of just 0.262%. All of these mutual fund expense ratios were at the lowest they had been in many years in 2008. Unfortunately fees are on the rise thus far in 2009.
Mutual Fund Expenses and Loads ExplainedA mutual fund is like any other business, it incurs expenses during operation. The key is understanding what these expenses are and being able to discern what is reasonable and what is not. Annual operating expenses include things such as management fees, distribution fees, and things such as legal fees or accounting expenses. Management fees often make up a large portion of the expenses, and they are typically the fees paid out to the advisers of the fund itself for managing the account. Distribution fees, which include the now common 12b-1 fee, typically account for things such as advertising of the fund and compensation for brokers who sell it.
Mutual fund loads are commissions charged by the investment firm that generally go directly to the brokers who have sold the fund. A broker who initiates a purchase into this investment option will likely be getting a hefty percentage of this sale. There are two common types of loads, a front-end load and a back end-load. A front-end load is when the investment company takes a percentage the initial investment. A back-end load simply means that the fees are accessed when the holdings are sold.
Mutual Fund Fees and Expenses Are Important To Understand
It's impossible to overstate the importance of finding an investment with reasonable fees and expenses. Fees and expenses often make or break the overall return inside this asset class. In order to avoid being left behind by the overall market, evaluate the expense ratio and all fees associated with the investment.
As an investor there is no excuse for paying huge annual expense ratios or being subjected to loaded mutual funds. In today's investing environment there are plenty of low cost mutual funds available. No load mutual funds are an absolute must since they perform just as well as their loaded counterparts, and they don't charge any commission when the transaction is made. A mutual fund fee calculator like the one the SEC provides on their website is a valuable tool for considering the costs associated with a prospective investment. Proper research allows an investor to reduce the fees and expenses related to a mutual fund investment.
References:
Asci, Sue "Mutual fund expense ratios at lowest level in years, Lipper says" May 28, 2009. August 7, 2009.
"The SEC Mutual Fund Cost Calculator: A Tool for Comparing Mutual Funds" February 28, 2006. August 7, 2009.
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