ManagingMoney.com Money Blog: Understanding Mutual Fund Costs

There are two broad classes of mutual fund costs: selling costs related to marketing of the mutual fund and operating costs related to the actual operation of the mutual fund. It is extremely important to understand these costs, as mutual fund expenses are the largest determinant of a fund's relative long-term performance.[1]

Selling Expenses

Front-End Load - A commission or sales charge paid when purchasing fund shares or re-investing in the fund. Front-end loads typically range between 4% and 8.5% and reduce the amount you invest by the load percentage. For example, investing $100,000 in a 5% load fund would reduce your initial investment to $95,000.
“Low-Load” funds charge between 1% and 3% of your initial investment and “No-Load” funds do not have any front-end sales charge.
A stock load fund may make up the sales charge in a relatively short period of time, often in less than a year. However, unless held for the very long term, the handicap of the load makes it almost impossible for even very well managed load fund to outperform no-load alternatives.

Back-End Load - A charge incurred at the time you redeem fund shares. The load may be a percentage of the redemption amount or a flat rate. The charge is usually 5% to 6% and declines by 1% a year over a period of five to six years. Back-end loads should be avoided because they dramatically reduce your investing flexibility.

12b-1 Plan - A method of charging selling expenses directly to the fund, usually as a percentage of fund assets. The general category of operating expenses often includes 12b-1 fees. This type of fee structure has become very popular as investors have become more aware of the pitfalls of paying sales loads. However, 12b-1 fees have the same negative effect on a fund's performance as a load.

Exchange fee - A charge levied when you switch from one mutual fund to another within a fund family. Generally, exchange fees range from $5 to $25.

None of the above expenses relate in any way to the investment management services of a fund. The idea that high fees or expenses are equated with “better” investment management is absolutely false.

Operating Expenses

These are the inherent costs of operating a mutual fund, including advisory fees paid to the investment manager and expenses incurred for fund administrative services. These costs range from under 0.2% to over 2% of a fund's assets and are usually expressed as a percentage called the “expense ratio”.

Note: A fund may temporarily suspend its management fee or absorb all of the funds operating expenses to enhance the fund’s returns. This is common with new funds. Be aware that when the fund does start charging its full operating expenses, this cost will reduce the fund’s returns by the expense amount.