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How Much Are You Paying for That Fund?

Posted by Larry Doyle on July 26, 2010 6:30 AM |

A few weeks back, I chastised a local financial commentator, Julie Jason, for her condescending demeanor toward Madoff investors. This week, I am happy to praise Ms. Jason for her intuitive nature and exploratory work on mutual fund fees and expenses.

All too often we hear asset managers touting their performance and investment expertise. I have hardly ever heard an asset manager addressing the fees and expenses charged for their so-called management expertise. To this end, I tip my hat to Julie Jason for highlighting this critically important topic in writing, Helping Figure Out the Fees:

You may have heard that mutual fund 12b-1 fees, part of the operating expenses of a fund, will be eliminated, which would imply that mutual fund shareholders could benefit from lower costs. Lower costs should mean higher performance.

Don’t be so hasty! Wall Street does not merely allow fees to walk out the door.

Last week, the Securities and Exchange Commission issued a proposal to end 12b-1 fees, which first were introduced in 1980. However, in reading the 278-page proposal, I don’t see the prohibition of fees to pay for distribution, the intended use of 12b-1 fees.

While some may disagree, I see a reframing of such fees as “asset-based sales charges” and “service fees,” with the goal of helping investors better understand what they are paying for. The fees currently are shown in the prospectus as a separate expense of the fund, which together with other fund expenses, such as accounting and legal fees, are included in “total operating expenses” — also called the “expense ratio.”

Fees? Asset-based sales charges? Service fees? Total operating expenses? Expense ratio? Are you kidding me? Do you feel like the Wall Street smoke and mirrors are working overtime here? You’re right…and in the midst of that smoke, you’re getting squuezed!! How so?

For example, a fund whose expense ratio is 1.5 percent per year might have a 12b-1 fee of 0.25 percent per year. Part or all of the 12b-1 fee might be paid to the stockbroker who sold the fund to you, and payable for as long as you stay with the fund and the broker. Consumers may not understand that funds offer different share classes with different pricing, and some share classes paying more to the broker than others.

I did a quick search on Morningstar’s Principia’s most recent database of mutual funds and found 4,301 funds with 12b-1 fees of 1 percent per year. Some 4,084 of these funds also had a deferred load ranging from 0.5 percent to 6 percent.

Deferred loads are payable when you redeem the fund and typically decline over time to zero — the longer you hold the fund, the lower the deferred load. A fund also could have a front load or sales charge, which is a one-time fee that comes off the top of your investment when you buy the fund.

Only one fund in this screen of 4,301 funds had a front load as well as a deferred load. That fund had a 12b-1 of 1 percent, a deferred load of 1 percent, a front load of 1 percent and an expense ratio of 3.3 percent.

Is your head spinning yet? Do you feel that you are in the “you can pay me now, you can pay me later, or you can pay me now AND you can pay me later” merry go-round? Well, you are!! Let’s cut through all the nonsense.

The average net expense ratio for the group of 4,301 funds was 2.08 percent. The median was 2.03 percent. Sixteen funds had expense ratios of more than 4 percent, with one at 11 percent.

An average net expense ratio of 2.08 percent. Wow! Do you feel like you are getting your money’s worth?

Real sense on cents believes an average expense of 2 % is egregious, if not usurious.

Thank you Ms. Jason for highlighting this topic.


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