Understand Fees Before Buying Mutual Funds

Maximize Fund Returns With Lower Transaction and Management Fees

Jul 17, 2009 Miranda Miller

The cost of buying mutual funds and maintaining ownership is an important factor when choosing an investment. Learn about MER, back end and front load mutual funds.

A mutual fund consists of a number of stocks and bonds grouped together and managed by one person, the mutual fund manager. These funds help investors diversify their portfolio, with ownership in several stocks and bonds and the guidance of a professional money manager.

This guidance and management comes at a cost, though. Before buying into a back end, front load, or no load mutual fund, understand all of the associated transaction and management fees.

Mutual Fund Management Fees

The Management Expense Ratio, or MER, is the percentage of the value of the fund that goes directly towards its operation. It is important to understand how the MER works. It is not a dollar figure that investors will see subtracted from their return. Rather, the MER value is taken off of the top of the value of the fund, reducing the potential return for all investors.

The B.C. Securities Commission's Invest Right website estimates that MER fees range from less than 1% to more than 3%. They note that a higher MER generally reflects a higher rate of risk, with more portfolio activity and trading. Lower activity funds, such as index funds, usually have lower MER's.

Paying the Mutual Fund Manager & Administrative Expenses

The mutual fund managers rate of pay is included in the MER and ranges from 0.5% to 1% of the overall fund value. Mutual fund managers are paid to manage risk, so consider the amount of risk and size of fund involved. A mid-sized $5 million index fund with a lower degree of risk, for example, pays $500,000 at 1% to the mutual fund manager. It is up to the investor to compare these rates of pay with the degree of risk for several funds to decide which offer the best value.

Administrative expenses are another necessary cost, but one that must be understood to ensure that investors are receiving the best value. These costs are also included in the MER and should cover necessities such as postage, office supplies, and customer service. However, they might also include extras such as cappuccino machines, fine furniture and a lavish office. Understand where fees are going to decide if the fund is a good value.

The MER might also include trailer fees paid to the selling agent for the life of the investor's ownership, legal and audit fees, and prospectus fees.

Back End, No Load or Front Load Mutual Funds

Load fees are sales charges investors pay to buy into the mutual fund. Many funds now offer no load purchasing; however, the sales charge may actually be wrapped into the MER instead of charged upfront, as with a front load fund.

Back end load fees are also known as deferred sales charges. Also a percentage of the fund value, this fee becomes lower the longer the investor owns the fund. Once the deferred sales charge schedule expires, the investor is free of the load fee.

Other Fees to Consider Before Buying Mutual Funds

Some funds offer an insurance option, where the investor pays a small percentage of the overall value of the fund to protect their principle. These deals are usually conditional on a certain period of ownership, usually ten years or more.

Trading fees are not included in the MER and are incurred when the mutual fund manager buys or sells securities. Do not forget the taxes that will have to be paid on the dividends, interest and capital gains the fund passes on to the investor. All of these additional expenses can eat into the value of the fund and lower fund returns.

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