Mutual Funds Can Be A Safe Investment, But Beware Of Fees

One of the biggest questions investors ask themselves is how they can make the most return on their money without taking a lot of risk. For this reason, millions of people turn to mutual funds. In fact, according to the 2014 Investment Company Fact Book. the U.S mutual fund industry is the largest in the world, with $15 trillion in assets. While you have likely heard the names of a few of the largest mutual fund families thrown around- T. Rowe Price, Vanguard, and Fidelity, you may have some questions about exactly what a mutual fund is, why people choose them, and the fees that are involved.

What Is A Mutual Fund?

A mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments, commodities, REITs – and the list goes on. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and/or income for the fund’s investors. What exactly will a mutual fund buy for you? Specific securities and answers to this question will be found in each fund’s prospectus, a document that gives a detailed outline of what and how a fund plans to and is currently investing your money.

Why Investors Choose Mutual Funds

Professional management. A lot of people are interested in investing their money, but have no idea where to start, the questions to ask, or have the time it takes to properly research their best investment choices. Mutual funds provide a place for people to put their money knowing it will be managed by a knowledgeable fund/portfolio manager. The portfolio manager will decide where to invest your money in the fund, determine when to buy and sell investments, and will strive put your money to work in a way that will meet your overall financial goals.

Affordability. Some mutual funds require only $500 to start investing, therefore mutual funds make investing accessible even to investors just getting started.

Liquidity. Unlike many other investment vehicle such as annuities, real estate, and hedge funds, it is easy to redeem mutual fund shares at any time. Typically (with no-load mutual funds) once you redeem (or sell) you will receive the fund’s net asset value (NAV) at that day’s close of business. Not all mutual funds are “no-load” so be aware that some mutual funds charge redemption fees or surrender penalties when selling. Also be aware that there can be a host of other fees that every investor should be properly educated about (see below).

Diversification. Your fund manager will invest your money in a range of securities including stocks, bonds and money market instruments. They typically invest in a variety of companies and industries in order to mitigate risk if a company fails or an industry performs poorly.

Buyer Beware: Mutual Fund Fees

While mutual funds are attractive because they are affordable, liquid, and professionally managed, it is imperative to identify up front any mutual fund fees associated with your investment. Brokerage firms, big banks, mutual funds and investment firms can’t manage your money for free and need to charge for their expertise and counsel. However, fees that are imposed on investors can take up from 5% to 30% of their return per year. The first step to avoiding exorbitant fees is to understand them.

Mutual fund fees (sales loads). There are plenty of good mutual funds that don’t charge sales loads or high fees in general – but there are still thousands of mutual funds that charge a “load” (usually 1 to 5%) to access the fund. Your investment advisor should offer you a way to have access to “no-load” (funds that do not have an upfront or back-end fee) or institutional share classes. No-load funds have no barriers to entry or exit, and institution share classes generally have much lower annual fees.

Mutual fund surrender penalties. Surrender penalties are a tricky way for a mutual fund company to force to you to leave your money in it’s fund – usually for several years. Penalty periods can be as long as eight years and cost as much as 8 percent of the value of your investment.

Internal mutual fund operating costs. Mutual fund managers make their living from the fund’s expense ratio. The charges very greatly from fund to fund. High-priced “actively” managed funds that seek to outperform the market (and rarely do on a consistent basis), are in the 1 to 1.5 percent range. Index funds that attempt to “passively” track the return of the market require much fewer people/staff/research and have dramatically lower fees (0.1-0.4%).

12b-1 fees. Known as 12b-1 fees. these are marketing fees that mutual fund companies give back to advisors and firms that put and hold their clients in the fund. There is a lot of debate right now about how 12b-1 fees should be disclosed and whether or not they are appropriate.

Don’t let mutual fund fees scare you. Overall, mutual funds can be a good option for investors large and small. However, educate yourself before making any big decisions. Ask your advisor or broker exactly how they are getting paid and the ways that you are paying for their service.

Wes Moss is the host of the Money Matters radio show on WSB Radio, host of the TV show Atlanta Tech Edge on Atlanta’s NBC affiliate, and Chief Investment Strategist at Capital Investment Advisors. In 2014, he was named one of America’s top 1,200 financial advisors by Barron’s Magazine. He is the author of several books including his most recent, You Can Retire Sooner Than You Think - The 5 Money Secrets of the Happiest Retirees . which has been one of Amazon’s best-selling retirement books in 2014.