Mutual Funds—Clearing the Confusion about CostSubmitted by HearthStone | Private Wealth Management on September 2nd, 2016
Mutual Funds—Clearing the Confusion about Cost
Mutual funds are popular investment options for millions of Americans. In fact, for many people, “investing” means throwing some of their money into mutual funds. Trillions of dollars are currently invested in mutual funds. But, like most things involving investments, the picture isn’t always clear. So, let’s clear up what you need to know about mutual funds.
Each mutual fund is, in essence, a business. There’s a board of directors, legal and tax advisors, as well as management, marketing, sales, and other business operations. All of this costs money to operate and maintain. The business has only one form of revenue: the fees it collects. Any earnings from the investments belong to the investors, net of fees. Ultimately the shareholders—that's you and I—are responsible for paying for all of the costs of running their business.
To keep it simple, let’s separate all the costs into two general categories. On the one hand, there are the costs of managing and operating the fund on a day-to-day basis. On the other hand, there are the costs associated with marketing and sales.
As an investment advisor, we often use mutual funds for our clients. And, since we choose the funds on behalf of our clients, there’s no need for someone to “sell” the fund to them. That generally means we can strip away all of the costs associated with marketing and sales, which can be substantial.
Other investors may pay fees when they buy or sell shares in a mutual fund. These fees are called “loads.” This is where things can get really confusing. Some mutual funds come in different versions, called “classes” of shares. The most common are classes A, B, and C. According to Mike Alfred, co-founder of Brightscope in San Diego, California, which tracks retirement plans, "Most of these share classes weren't designed to help investors. They were designed to pay someone else."
[Source: WSJ: Beware Fund Share Class Fees by Jack Hough February 2012].
Without going any further into defining these classes of shares, what I tell people is, A-B-C should stand for “Always Be Cautious.” In other words, if you see any of these three letters associated with the fund you’re buying, beware! You’re paying an amount, often a hefty sum, to someone who is selling the fund to you. Making matters more onerous, the fund industry often “hides” costs through unfamiliar jargon and complexity. If you don’t know what this amount is, or to whom it is paid, ask!
If you can strip away the marketing and sales expenses, there’s still the cost of management and operations. Clearly, costs can significantly eat into returns. Cost should be carefully weighed against the anticipated benefits. You can also “Google” the fund’s symbol, which often provides more specifics about its expenses.
In our case, we strive to always use the lowest cost version, or class available. That’s generally called the “I” class, standing for “institutional” class.
Investing in the market can enable some investors to build wealth over time. However, proceed with caution. Ask lots of questions. And of course, call our office anytime if you’d like more information about how mutual funds work.