Mutual fund fees come with names that sound like they were designed to be skipped over. “Expense ratio.” “Contingent deferred sales charge.” “12b-1.” But each one is just a way of taking a percentage of your money, and once you know what they are, you can compare two funds in a couple of minutes.
The SEC’s investor education site, investor.gov, has a glossary and an investor bulletin on fund fees that cover all of these. What follows is the same ground in plainer terms, with examples.
The expense ratio
The expense ratio is the yearly cost of owning the fund, stated as a percentage of your investment. It covers the manager’s fee, administration, record keeping and similar running costs. If the 12b-1 fee exists, it is included in this number too.
You don’t pay it as a bill. The fund deducts it from its assets a little at a time, so it shows up as slightly lower returns. A fund with a 0.60% expense ratio costs about $60 a year for every $10,000 you have in it. A fund at 0.05% costs about $5.
That sounds trivial until you remember it repeats every year on a balance that is, you hope, growing. On a $200,000 retirement account, the difference between 0.60% and 0.05% is about $1,100 a year.
Look for the total annual fund operating expenses line in the fee table of the prospectus. If the fund has a fee waiver, there will also be a net figure after the waiver. Check whether the waiver has an end date.
Sales loads
A load is a sales commission. It usually goes to the broker or advisor who sold you the fund, not to the fund itself. There are two main kinds.
Front-end load
This is taken out when you buy. If you invest $10,000 in a fund with a 5.75% front-end load, $575 goes to the sales charge and $9,425 actually gets invested. Your account starts out behind, and the fund has to earn about 6.1% just to get you back to $10,000.
Many load funds offer breakpoints, which are lower load percentages once you invest above certain amounts, such as $50,000 or $100,000. If you’re buying a load fund, ask what the breakpoints are and whether money you hold in the same fund family counts toward them. The prospectus lists them.
Back-end load
This is charged when you sell. The common version is a contingent deferred sales charge, which starts at a set percentage and shrinks each year you hold the fund, often reaching zero after several years. Sell in year one and you might pay 5%. Sell in year seven and you might pay nothing. The prospectus has the schedule.
Back-end loads can feel free because nothing comes out on day one. They aren’t free. They limit when you can leave without a penalty, and the share classes that carry them often have higher yearly expenses too.
12b-1 fees
A 12b-1 fee, named after the SEC rule that allows it, is an ongoing yearly fee that pays for marketing and distribution of the fund, and sometimes for shareholder services. In practice, a lot of it pays the broker who sold you the fund, every year you keep it.
According to the SEC’s investor bulletin on fund fees, FINRA rules cap the distribution and marketing part at 0.75% of a fund’s average net assets per year, and shareholder service fees at 0.25% per year. So a fund can charge up to 1% a year in combined 12b-1 fees.
The SEC also notes that a fund with 12b-1 fees above 0.25% a year can’t call itself a “no-load” fund. That’s worth knowing because “no-load” is a phrase people trust. A no-load fund may still carry a 12b-1 fee of up to 0.25%.
12b-1 fees are mostly a mutual fund feature. ETFs typically don’t charge them.
Share classes, where it all comes together
The same fund is often sold in several share classes with different fee mixes. A common pattern looks like this:
- Class A: front-end load, lower 12b-1 fee. Breakpoints can bring the load down for larger purchases.
- Class C: little or no front-end load, a small back-end charge if you sell within about a year, and a higher 12b-1 fee that continues as long as you hold it.
- Institutional or advisor classes: often no loads and low expenses, available through retirement plans, certain platforms or larger minimums.
Letters vary between fund companies, so read the fee table rather than relying on the label. The underlying investments are identical across classes. Only the costs differ, which means the cheaper class will earn more over time, by exactly the fee difference.
Fees that are not in the expense ratio
A few costs sit outside these three:
- Trading costs inside the fund, which reduce returns but aren’t part of the expense ratio. Funds that trade a lot tend to have higher ones.
- Purchase or redemption fees some funds charge to discourage short-term trading. These go to the fund, not a broker.
- Account fees from the brokerage or plan, such as yearly maintenance fees on small accounts.
- Advisory fees if an advisor manages your money, often around 1% a year, charged on top of the funds’ own costs.
To compare two funds quickly, open each prospectus to the fee table and look at three lines: the maximum sales charge on purchases, the maximum deferred sales charge, and total annual operating expenses. The fee table also includes an example showing what you’d pay on a $10,000 investment over 1, 3, 5 and 10 years. Put those two examples side by side and the cheaper fund is usually obvious.
This post is general information, not financial advice.