The investment world is at times a financial maze because of the twists and turns leading you thru some blind alleys before reaching the final point. Our final point is how the invested funds grow and at what cost.
It is common practice for Financial Advisors and Investment Planners to be tied to a mutual fund company or a larger investment bank. In this situation, they would offer to diversify your portfolio by investing it in a cluster of mutual funds they are tied to. In return for carrying out your investment plan, you would have agreed to pay the investment advisor an advisory fee which normally shows up in the invoice sent to you by the advisor. But there are hidden fees and costs that do not appear there.
How much you could be paying on a $100,000 portfolio.
We are going to use an investment amount of $100,000 to show you how some of these costs can affect your investment portfolio. They can one or a combination of what we are going to discuss now. We are entering a caution zone and I would strongly suggest that you have a pen and paper handy to note down the pointers to these fees and costs that are not obvious on your advisory statement.
The first of this fee is the
Sales Charge or Front-end Load
This typically goes to the brokers that sell the fund’s shares or if the person is your financial advisor or planner who bought this fund for your portfolio, the fee would go to him.
Front-end load is an upfront charge and it reduces the amount of your investment. Let us take our investment amount $100,000. If you or your financial advisor or planner decides to invest it in a mutual fund with a 5.75% front-end load. $5,750 sales load will be deducted right at the onset and only $94,250 will be invested in the mutual fund shares for you.
If you are investing through a 401K or any other retirement plan through an advisor who uses mutual funds with a front-end load, every time you or your employer makes a contribution, you are charged these fees and the advisor makes money on a continuous basis.
NASD rules allow a charge of up to 8.5% front-end load of your investment.
Now there is another type of charge that is deducted from your investment when you sell the fund shares and this is
Deferred Sales Charge (Load)”Also known as a back-end load, and this fee as well goes to the brokers or financial advisors who sell the funds shares.
Let us assume a deferred sales charge of say 6.25%. If your $100,000 had grown to $110,000 at the end of a year and your advisor decides to sell the shares of the fund, $6,250 which is 6.25% of the initial amount of your investment will be deducted from your assets and only $103,750 will be available to you. Now another scenario is, if your investment had gone down to $50,000 from $100,000, like many of the investors had done during this recession, you will still have to pay $6,250 and here you will only receive $43,750. So let us get this clear…. if the fund has a deferred sales charge, irrespective of the fact whether your investment appreciated or it depreciated, you will have to pay it and your broker or advisor who sells or invests for you in the fund will make money. Some funds charge you the Back-end load on the final amount at the time of sale.
There is another type of back-end sales load known as contingent deferred sales load and if a fund has this type of load you will have to hold the fund for set number of years for the charge to decrease to zero. Some investors are stuck with a bad investment in order to avoid these charges. But tell me, should you be penny wise and pound foolish. If you see that it is badly managed fund and does not meet your investment goals, it is better to get out of the fund and put your money to use elsewhere.
Redemption Fee. This is charged when the shareholders sell or redeem shares of the fund.
Unlike a deferred sales load, a redemption fee is paid to the fund and not to a broker. Typically, a fund can charge you up to 2% redemption fee. Coming back to our investment amount of $100,000, if you had already paid 5.75% as Front-end load and the fund has another 2% Redemption fee, then your total charge would be $5750 + $2000 = $7750. Now let us look at some important ongoing expenses that are charged to your account,
Management Fees. This is paid out of fund assets to the funds investment advisor for investment portfolio management.
This is an ongoing annual fee charged to your portfolio, and this is on top of the advisory fee you pay. Coming back to our amount of $100,000. If you or your advisor decide to invest in a fund that has a management fee of 0.80%, $800 will be charged to your account every year. Now if your fund had a front end load as well of 5.75% than your out of pocket cost would be $5750 + $800 of which $800 is an ongoing cost and $5,750 is a one off cost.
12b-1 Fees. This is paid out of the fund assets and is also called Distribution Fees. Distribution fees include fees to compensate brokers and others who sell fund shares and to pay for advertising, the printing and mailing of prospectuses to new investors. All these expenses go out of your investment as an ongoing annual cost.
Continuing with our example of $100,000, say if the fund had 0.25% 12b-1 fee, then you will pay another $250 on an ongoing basis.
So a total of $800, for the management fee and $250 for the distribution fee that is a total of $1,050 will be charged to you annually on an ongoing basis. And this represents 1.05% fee on your total investment on top of the advisory fee. This amount will vary depending upon the size of your investment.
So when you see any appreciation at all in your investment portfolio, you see it after all these hidden fees and costs have been deducted. And mind you, even if your investment had depreciated over 30% like many investors suffered during the financial market crisis, you still had been charged all these hidden fees and costs. Trust me these costs tend to increase your time to retirement by several years.
Due to time constraints, I was only able to show some of the most important and commonly occurring hidden fees and costs, but I strongly urge you to go over your investment statement thoroughly and also visit the following website shown on the screen to get more information on the various fees & costs involved in mutual fund investing.
The following website shown on the screen will help you work out the costs and fees and then compare it with the invoice from your financial advisor.
There are several… actually hundreds of no-load mutual funds that are five-star rated by Morningstar. You could check them out going to www.morningstar.com … the address you see on the screen. You could also check their expenses and costs that are passed on to you. Also you can make sure their strategy and style suits your risk profile. Of course, here you would need help from a well qualified professional investment manager who does not have a vested interest in choosing the right funds for you.
Mutual fund investing indeed gives you diversification if you have a small portfolio. But if you have a larger portfolio you are better off engaging a well qualified Portfolio Manager who can create a portfolio of stocks and bonds that fits your risk and return profile.
Click on the video link provided on the side bar of this page to watch a detailed representation of all the hidden fees and costs you right be paying on your hard-earned assets!