An educated investor is the best investor. We like it when Sarasota residents take an interest in their investment allocations, our reasons for choosing funds, and the investing fees associated with each ETF or Mutual Fund they invest in.
There are two general types of mutual funds your local Sarasota financial advisor can offer you: load funds and no-load funds. The latter does not charge a commission for their purchase or selling, hence the name. Load in this context means commission. No-load funds are usually passively-managed mutual funds or ETFs. This probably means that they simply mirror an equity index, such as the S&P 500.
There are three types of load funds: front-end loads, back-end loads, and level loads. They are alternatively called A-class, B-class, and C-class shares, respectively. Sneaking into the mix are the R-class shares, which don’t technically carry a load but still pay a commission nonetheless.
Front-load funds charge a 3.75% to 5.75%(1) commission when you purchase the mutual fund. In many cases, the more money you invest, the less the commission will be.
Back-load funds charge a commission when an investor sells a mutual fund. These are generally better than front-end loads because the commission percentage often goes down the longer you hold the mutual fund, usually yearly. It may eventually disappear. For example, if you sell the mutual fund in the first year, you may pay 5% of its value at the time of purchase (not on growth). In the second year, 4%. After five years, the commission disappears. Back-loads encourage long-term holding strategies that are vital for investing success.
Level-load funds charge an investor a certain percentage of the overall investment value each year.
R-class shares are only available through 401(K) retirement plans. They don’t carry an official load, though they do carry 12b-1 fees.
These are what brokers refer to as shareholder fees. Some actively-managed funds may or may not charge them, depending on the broker.
These are the investing fees associated with the physical management and maintenance of the mutual fund. Before we get into them, we must inform you that only some of these fees apply to every mutual fund. If all of them did apply to a single mutual fund, we would avoid that fund like the plague because the total annual costs ratio would be through the roof.
This fee pays for marketing a mutual fund to attract more investors. Perhaps the funds’ marketers take out ads in investing journals or print out brochures to be passed around at conferences to “spread the gospel” of the fund.
These are necessary expenses as the people managing the fund need to receive a salary for their work of actively purchasing and selling stocks to ensure the fund’s composition reflects the stated goals of the prospectus. This fee can vary widely, depending on how often the fund manager makes trades in and out of the fund.
This fee comes from an investor when mutual fund shares are purchased. Unlike a load, the funds are put directly back into the fund for the benefit of long-term shareholders. It incentivizes investors to wait to sell their shares to help recover the loss incurred when purchasing the share.
This fee occurs when an investor sells mutual fund shares. Like a purchase fee, the money goes into the fund’s pool of money. It also gives the incentive to trade sparingly. Basically, the less you trade, the less you will rack up in trading fees.
These fees occur when an investor transfers assets from one mutual fund to another mutual fund managed by the same company. An advisor may elect to relocate assets to more bearish or bullish mutual funds depending on an investor’s shifting risk tolerance due to age, income, or other life factors.
These apply to the maintenance of an account. Usually, you incur account fees when an account falls below an account minimum.
You can find the above annual operating expenses in a fund’s prospectus. The management fees and 12b-1 fees comprise a mutual fund’s expense ratio.
Besides the fees covered by the prospectus, there are other costs associated with mutual funds and ETFs that aren’t so obvious. Here’s a quick rundown of them.
A mutual fund has a bid/ask spread like a regular stock, currency, cryptocurrency, or any other investment sold on an exchange. If a mutual fund has a bid price of $40 and an asking price of $39, you will lose a dollar if you purchase at the bid and immediately sell at the ask. When you look up an asset’s value on Google, you see the mid-price. The greater the spread, the more you are losing in relation to the mid-price, and the greater the underlying asset’s worth will have to move in one direction or the other to make up for the spread.
Funds incur these hidden investing fees when a mutual fund purchases a large block of stocks at such a scale that the price of the stock increases due to the sudden demand. This can also occur when a block of stocks is sold, causing a crash in the price. Retail investors rarely have such an issue because they don’t buy or sell in such quantities that they cause higher-than-usual demand or create panic.
You determine a fund’s turnover rate by adding up all the purchases and profits realized through sales by a fund over a year, dividing it into the Net Asset Value (NAV), and times it by 100 to come up with the percentage. If it is 50%, the fund manager shuffled in or out half of the fund’s underlying assets over the year. While a high turnover rate isn’t necessarily terrible, the fees associated with purchasing and selling can eat into a fund’s performance.
Putting it all together, you have the Total Annual Cost, which can take time to calculate, considering the many factors involved. What we should focus on is the expense ratio. Many of the country’s top investors, such as Warren Buffet, have long since stressed the importance of low-expense ratios when purchasing ETFs and Mutual Funds, even though they make up just a portion of the investing fees.
Investing fees aren’t the only thing impacting your portfolio however. In this article, we haven’t discussed tax strategies, dividends, the difference between mutual funds and ETFs, and inflation – all of which also play a considerable role in the success of your portfolio.
And that’s why having a financial advisor is so important, especially if they are tax professionals as well!
We put together comprehensive and holistic financial plans that consider every factor so you can have a retirement-ready nest egg when the time comes.
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