How to Get the Most Out of Mutual Fund Fees

Most savvy investors know that it costs money to invest. Whether you are selling real estate and paying a realtor’s commission or you are trading stock and paying commissions to a broker, part of your return is going to be eaten up in fees.

These fees are part of the game. Expected. Predictable. Perhaps, inevitable. But how high a fee are you willing to pay?

The question is particularly germane to those who invest in mutual funds. In essence, they are paying higher fees than the average investor for the luxury of having someone else handle their investments for them. But the variation in what is paid to the fund’s managers and agents can be staggering.

In the worst cases, the fees can wipe out any investment gains on the customer’s account. In the best cases, the fees are so small that they’re invisible and insignificant.

With mutual funds, fees come in three varieties: the “load,” which is usually an upfront sales charge paid to the broker or financial adviser who sells the fund’s shares; management fees, which are annual charges that pay for the fund’s investment advisers; and 12b-1 fees, which are essentially marketing fees that are passed on to investors.

The load is frequently the largest of the fees. It can be up to 8.5% of invested assets. Management and 12b-1 fees combined usually amount to less than 2% of assets.

Because the loads can be so substantial, many investors believe the best strategy is to buy so-called no-load funds, which have no upfront sales charges whatsoever.

However, some say paying a load makes sense in the right circumstances. For example, it makes sense to pay a load when that fund’s performance is so much better than comparable no-load and low-load funds that the fee is more than made up for in performance.

That’s unusual, however. According to an analysis of 190 growth funds with loads of 4% or more and 143 no-load funds, performance of the two types of funds is close enough that the advantages of choosing one type over the other on the basis of fees alone is debatable, said John Rekenthaler, editor of Morningstar Mutual Funds, a Chicago-based mutual fund information service.

Over a 10-year period, the average annual return for the no-load funds was 15.19%, while the average return for the load fund was 15.35%. Over five years, the no-load returned 12.88% and load funds 13.57%. Last year the average annual return for the no-load was 34.21% versus 36.2% for the load fund.

When the loads were factored in, the differences were negligible, Rekenthaler said. And, generally speaking, the load fund managers took greater risks with investor money.

However, performance is not the only reason to pay a load. It makes sense to pay a fee when you’re getting a service that performance can’t measure--such as needed advice.

While some investors know exactly what they want and how to find it, others need some guidance. And these investors may be well served to buy mutual funds through financial planners and stock brokers who almost always deal in “loaded” mutual funds. But you should get something valuable for your fee.

For example, the broker or financial planner should help you analyze how much risk you can tolerate and what funds best suit your investment goals. The broker should also be willing to share mutual fund reports that track the recommended funds’ performance over time. And the broker or planner should continue to provide information and advice to the investor for as long as they hold that fund’s shares.

If the adviser does a good job, the investor’s money is well spent.

Investors also need to be aware of a mutual fund’s operational costs, which include both management and 12b-1 fees. Even though these fees usually amount to less than 2% annually for long-term investors, these could be far more significant than the loads.

Again, performance should help measure whether the fees investors are paying are reasonable. Generally speaking, it makes sense to pay more for management when those managers are able to consistently outperform the market or their peers.

But operation fees do have low, high and moderate ranges, Rekenthaler said. For a stock fund, normal charges would range between 0.75% and 2%. Less than 1% is generally considered a low fee, while anything over 2% is “getting pricey,” according to Rekenthaler.

For bond funds, the range would be lower--between 0.5% and 1.25%, Rekenthaler said.

Some international bond funds might charge more, but “there would have to be a compelling reason why you would want to be in that fund versus another” less expensive fund, Rekenthaler added.