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What Mutual Fund Fees and Expenses Should I Be Aware Of?
As with any business, running a
mutual fund involves costs. For example, there are costs incurred in
connection with particular investor transactions, such as investor purchases,
exchanges, and redemptions. There are also regular fund operating costs that are
not necessarily associated with any particular investor transaction, such as
investment advisory fees, marketing and distribution expenses, brokerage fees,
and custodial, transfer agency, legal, and accountants fees.
Some funds cover the costs associated with an individual investor’s
transactions and account by imposing fees and charges directly on the investor
at the time of the transactions (or periodically with respect to account fees).
These fees and charges are identified in a fee table, located near the front of
a fund’s
prospectus, under the heading
"Shareholder Fees."
Funds typically pay their regular and recurring, fund-wide operating expenses
out of fund assets, rather than by imposing separate fees and charges on
investors. (Keep in mind, however, that because these expenses are paid out of
fund assets, investors are paying them indirectly.) These expenses are
identified in the fee table in the fund’s prospectus under the heading "Annual
Fund Operating Expenses." A frequently asked question is whether the SEC
imposes any specific limits on the size of the fees that a fund may
charge. The short answer is the SEC generally does not, although the
SEC limits redemption fees to 2% in most situations. The National
Association of Securities Dealers, Inc. (NASD), however, does impose
limits on some fees.
Under the heading of "Shareholder Fees," you will find:
Sales Loads (including Sales Charge (Load) on
Purchases and Deferred Sales Charge (Load))
Redemption Fee
Purchase Fee
Exchange Fee
Account Fee
Under the heading of "Annual Fund Operating Expenses," you will find:
Management Fees
Distribution [and/or Service] (12b-1) Fees
Other Expenses
Total Annual Fund Operating Expense
Shareholder Fees
Funds that use brokers to sell their shares must compensate the brokers.
Funds may do this by imposing a fee on investors, known as a "sales load"
(or "sales charge (load)"), which is paid to the selling brokers. In this
respect, a sales load is like a commission investors pay when they purchase
any type of security from a broker. Although sales loads most frequently are
used to compensate outside brokers that distribute fund shares, some funds
that do not use outside brokers still charge sales loads.
The SEC does not limit the size of sales load a fund may charge, but the
NASD does not permit mutual fund sales loads to exceed 8.5%. The percentage
is lower if a fund imposes other types of charges. Most funds do not charge
the maximum.
There are two general types of sales loads—a front-end sales load investors
pay when they purchase fund shares and a back-end or deferred sales load
investors pay when they redeem their shares.
Sales Charge (Load) on Purchases
The category "Sales Charge (Load) on Purchases" in the fee table includes
sales loads that investors pay when they purchase fund shares (also known as
"front-end sales loads"). The key point to keep in mind about a front-end
sales load is it reduces the amount available to purchase fund shares. For
example, if an investor writes a $10,000 check to a fund for the purchase of
fund shares, and the fund has a 5% front-end sales load, the total amount of
the sales load will be $500. The $500 sales load is first deducted from the
$10,000 check (and typically paid to a selling broker), and assuming no
other front-end fees, the remaining $9,500 is used to purchase fund shares
for the investor.
Deferred Sales Charge (Load)
The category "Deferred Sales Charge (Load)" in the fee table refers to a
sales load that investors pay when they redeem fund shares (that is, sell
their shares back to the fund). You may also see this referred to as a
"deferred" or "back-end" sales load. When an investor purchases shares that
are subject to a back-end sales load rather than a front-end sales load, no
sales load is deducted at purchase, and all of the investors’ money is
immediately used to purchase fund shares (assuming that no other fees or
charges apply at the time of purchase). For example, if an investor invests
$10,000 in a fund with a 5% back-end sales load, and if there are no other
"purchase fees," the entire $10,000 will be used to purchase fund shares,
and the 5% sales load is not deducted until the investor redeems his or her
shares, at which point the fee is deducted from the redemption proceeds.
Typically, a fund calculates the amount of a back-end sales load based on
the
lesser of the value of the shareholder’s initial investment or the value
of the shareholder’s investment at redemption. For example, if the
shareholder initially invests $10,000, and at redemption the investment has
appreciated to $12,000, a back-end sales load calculated in this manner
would be based on the value of the initial investment—$10,000—not on the
value of the investment at redemption. Investors should carefully read a
fund’s prospectus to determine whether the fund calculates its back-end
sales load in this manner.
The most common type of back-end sales load is the "contingent deferred
sales load," also referred to as a "CDSC," or "CDSL." The amount of this
type of load will depend on how long the investor holds his or her shares
and typically decreases to zero if the investor hold his or her shares long
enough. For example, a contingent deferred sales load might be 5% if an
investor holds his or her shares for one year, 4% if the investor holds his
or her shares for two years, and so on until the load goes away completely.
The rate at which this fee will decline will be disclosed in the fund’s
prospectus.
A fund or class with a contingent deferred sales load typically will also
have an annual
12b-1 fee.
A Word About No-Load Funds
Some funds call themselves "no-load." As the name implies, this means that
the fund does not charge any type of sales load. As described above, however,
not every type of shareholder fee is a "sales load," and a no-load fund may
charge fees that are not sales loads. For example, a no-load fund is permitted
to charge purchase fees, redemption fees, exchange fees, and account fees, none
of which is considered to be a "sales load." In addition, under NASD rules, a
fund is permitted to pay its annual operating expenses and still call itself
"no-load," unless the combined amount of the fund’s 12b-1 fees or separate
shareholder service fees exceeds 0.25% of the fund’s average annual net assets.
A redemption fee is another type of fee that some funds charge their
shareholders when the shareholders redeem their shares. Although a
redemption fee is deducted from redemption proceeds just like a deferred
sales load, it is not considered to be a sales load. Unlike a sales load,
which is generally used to pay brokers, a redemption fee is typically used
to defray fund costs associated with a shareholder’s redemption and is paid
directly to the fund, not to a broker. The SEC generally limits redemption
fees to 2%.
A purchase fee is another type of fee that some funds charge their
shareholders when the shareholders purchase their shares. A purchase fee
differs from, and is not considered to be, a front-end sales load because a
purchase fee is paid to the fund (not to a broker) and is typically imposed
to defray some of the fund’s costs associated with the purchase.
An exchange fee is a fee that some funds impose on shareholders if they
exchange (transfer) to another fund within the same fund group.
An account fee is a fee that some funds separately impose on investors in
connection with the maintenance of their accounts. For example, some funds
impose an account maintenance fee on accounts whose value is less than a
certain dollar amount.
Annual Fund Operating Expenses
Management fees are fees that are paid out of fund assets to the fund’s
investment adviser for investment portfolio management, any other management
fees payable to the fund’s investment adviser or its affiliates, and
administrative fees payable to the investment adviser that are not included
in the "Other Expenses" category (discussed below).
Distribution [and/or Service] (12b-1) Fees
This category identifies so-called "12b-1 fees," which are fees paid by the
fund out of fund assets to cover distribution expenses and sometimes
shareholder service expenses.
"12b-1 fees" get their name from the SEC rule that authorizes their
payment. The rule permits a fund to pay distribution fees out of fund assets
only if the fund has adopted a plan (12b-1 plan) authorizing their payment.
"Distribution fees" include fees paid for marketing and selling fund shares,
such as compensating brokers and others who sell fund shares, and paying for
advertising, the printing and mailing of prospectuses to new investors, and
the printing and mailing of sales literature.
The SEC does not limit the size of 12b-1 fees that funds may pay. But under
NASD rules, 12b-1 fees that are used to pay marketing and distribution
expenses (as opposed to shareholder service expenses) cannot exceed 0.75
percent of a fund’s average net assets per year.
Some 12b-1 plans also authorize and include "shareholder service fees,"
which are fees paid to persons to respond to investor inquiries and provide
investors with information about their investments. Unlike distribution
fees, a fund may pay shareholder service fees without adopting a 12b-1 plan.
If shareholder service fees are part of a fund’s 12b-1 plan, these fees will
be included in this category of the fee table. If shareholder service fees
are paid outside a 12b-1 plan, then they will be included in the "Other
expenses" category, discussed below. The NASD imposes an annual .25% cap on
shareholder service fees (regardless of whether these fees are authorized as
part of a 12b-1 plan).
Included in this category are expenses not included in the categories
"Management Fees" or "Distribution [and/or Service] (12b-1) Fees." Examples
include: shareholder service expenses that are not included in the
"Distribution [and/or Service] (12b-1) Fees" category; custodial expenses;
legal expenses; accounting expenses; transfer agent expenses; and other
administrative expenses.
Total
Annual Fund Operating Expense
This line of the fee table is the total of a fund’s annual fund operating
expenses, expressed as a percentage of the fund’s average net assets.
A Word About Mutual Fund Fees and Expenses
As you might expect, fees and expenses vary from fund to fund. A fund with
high costs must perform better than a low-cost fund to generate the same returns
for you. Even small differences in fees can translate into large differences in
returns over time. For example, if you invested $10,000 in a fund that produced
a 10% annual return before expenses and had annual operating expenses of 1.5%,
then after 20 years you would have roughly $49,725. But if the fund had expenses
of only 0.5%, then you would end up with $60,858—an 18% difference. It takes
only minutes to use the
SEC's Mutual Fund Cost Calculator to compute how the costs of different
mutual funds add up over time and eat into your returns.
http://www.sec.gov/answers/mffees.htm
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