Cutting Fund Expenses

by Alan Lavine and Gail Liberman

It’s easy to get confused by all the fees you pay on mutual funds. Yet they cut into your returns. The more commissions and expenses you pay, the less you earn. So fees are very important to understand. Unfortunately, you can’t escape them all, but you can escape some.

All mutual funds charge annual investment management fees and administrative fees automatically deducted from your investment. These fees, along with “12 b-1 fees,” which cover marketing and shareholder services, make up what’s known as a fund’s “expense ratio.” An expense ratio simply is a way of expressing your ongoing annual fees--as a percentage of the fund’s net asset value.

See how you’re doing by comparing the annual expense ratio of your funds, available in your fund’s prospectus under “Total Annual Fund Operating Expenses,” with these averages. Data are according to Morningstar Inc., Chicago:

• Domestic stock funds: 1.46 percent.

• International stock funds: 1.70 percent.

• Balanced funds, which invest nearly equally in stocks and bonds: 1.5 percent.

• Bond funds: 1.03 percent.

Expect also to be charged commissions or “loads” if you buy funds from a financial adviser or broker. You may be able to choose how to pay these fees. Here are your options:

• Front-end load. You typically pay about 1.5 to 4.5 percent upfront commission.

• Deferred load. There is no upfront commission, but you pay a charge of 2 percent or more if you cash out during a specific period. Often, this charge declines over time.

• Level load. You typically pay a 1 percent ongoing annual charge.

• No load. You pay no commissions. You invest in these funds directly with the fund group or via a discount brokerage firm.

Say you invest $10,000 in a front-end load fund that charges 4.5 percent commission: You’ll pay $450. That leaves you with $9,650 to invest. Expect to pay about another $141 dollars in annual fund expenses.

On other types of load funds, including a back-end loaded fund, you have a larger initial investment, but beware that you may pay higher ongoing annual expenses.  On all funds, watch for redemption fees, which technically are not considered loads, but charge you for cashing out within a certain period; purchase fees for buying shares; and exchange fees for changing to another fund in the same family. Plus, you could owe a fee if your fund balance drops below a certain level.

If you are going to pay a fee to a broker or financial adviser, it’s important to make sure he or she is worth it. Here’s what a broker or adviser should do for you:

• Evaluate your goals and how long you have to invest.

• Determine your tolerance for risk, and adjust your investments accordingly.

• Evaluate all your other investments to make sure you have the best mix of stocks, bonds and other assets. You don’t want, for example, to invest in several mutual funds that own the same stocks.

• Pick the lowest-cost funds that deliver the best returns with the least amount of risk. The adviser should show you how the fund performed in both up and down markets.

The adviser also should disclose whether he or she is getting a bonus for investing in recommended funds.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.