There are numerous costs associated with investment funds. Two of the main costs are commissions (or loads) and management fees. These costs may seem minor but they add up over time. Few investors are aware of the full cost of investing in funds. This is because fund fees and expenses are charged to the fund, not directly billed to the investor.
Funds may be sold in different ways called distribution channels. The distribution channel, or who sells the funds to you, has a big impact on the fees charged. There are four distribution channels called share class categories. These are as follows.
There is also a second tier category of funds that is only available to high net worth (HNW) investors, as defined by a fund company (for example, individuals who are able to invest a minimum amount of $25,000 or more).
You may incur a cost when buying or selling a fund. These costs are referred to as commissions or loads. Ensure you ask for details of all charges before purchasing a fund. Some of the more common of these charges are:
Mutual funds or managed funds may charge a commission when you buy into the fund (that is, at the front end of the investment). Front-end loads are typically 1–3% of the total amount invested, although the rate may decrease as the amount invested increases.
For example, if you deposit $1,000 and the fund charges a 3% front-end commission fee, $30 of the amount invested is taken from the "front end" while $970 will actually be invested. This is a substantial fee, but if you believe that the fund will perform better than a fund that does not charge a front-end load, then the fee may be worthwhile. The front-end load is usually negotiable.
A back-end load is a sales charge similar to a front-end load, except that it is charged when you leave the fund (that is, at the "back end" of the investment).
Some mutual fund companies charge you a redemption or surrender fee if you leave the fund early. Others charge you the fee no matter how long you hold the fund. A surrender fee is typically 2%.
Most mutual funds have a back-end load, called a deferred sales charge (DSC), rather than a front-end load. This charge is based on a sliding scale. It may start as high as 8.5% and then decline to 0% over a period of time, typically six to eight years. For example, if you sell after three years, a 6% charge might be applied against the cashed-in amount.
The longer you hold a fund, the less you are charged when you sell it. A DSC is measured from the year of deposit, which means there may be a charge against monies you invested recently but not on monies you invested several years ago.
Newer low-load funds offer lower DSCs. Charges start at 3% or less and decline to 0% over a shorter period of time (for example, less than six years). Generally, these back-end loads are not negotiable.
If you invest in a no-load fund, you are not charged any upfront or deferred sales charges.
Every mutual fund has administrative and recordkeeping costs, as well as fees charged by the investment management team. Accordingly, there is always an annual fee applied against the value of an investor’s account to cover such expenses. There are three types of fees:
As the name implies, investment management fees are charged for the manager’s expertise and fund management of investments. These fees vary, depending on the type of fund. For instance:
Fund management fees are charged for expenses associated with client servicing and recordkeeping. This does not include advice. Fees charged by funds vary, as follows:
Collectively these annual fees are called the management expense ratio (MER). It can range from less than 1% to more than 3% per year.
Retail funds (from a commission-based advisor) are expensive. Compare the fee percentages below.
When you are evaluating funds for your portfolio, it’s important to take account of any fees you may be charged. If your company offers pension or investment plans with reduced fees, ensure you take advantage of those plans. Many employers' DC pension plans and group RRSPs have fund fees of less than 1%.
Check to see if your employer-sponsored pension and retirement savings plans use institutional funds. These plans offer the advantage of lower fees and no commissions.
While the difference of a percentage point or two may seem insignificant, over time, and as your portfolio increases in value, they can really add up. Take the following example as a case in point. A brother and sister, Rose and Ross both inherit $100,000 from great-aunt Beatrice. They both invest the money and get a 6% long-term return on their money, HOWEVER…
Employer-sponsored retirement savings plans may offer similar fees without the minimum size requirement.