Mutual funds and ETFs can be among the most cost-effective ways for individual investors to gain access to Wall Street's best investment opportunities. They can also be a rip off. If you understand what to look for, you can save yourself and your family significant amounts of money.
Commissions
: If you invest in mutual funds or ETFs through a brokerage account, you'll typically pay a commission. Discount brokerage commissions are modest: sometimes less than $10. If your investment size is modest, however, those commissions may be eating away a material part of your savings. Many discount brokers offer some mutual funds and ETFs that you can buy with no commission. When you are looking for investments, look first among those that you can buy commission free. You can also buy mutual fund investments direct from the mutual fund without a commission, but if you will end up owning several funds - and you should - you'll save yourself a lot of time buy buying your funds through a brokerage account so you can track your portfolio in one place online.
Loads
Loads are like commissions in that they are charged when you purchase the initial investment in the mutual fund. Loads can reach seven percent or more. Many mutual funds are offered without a load; these are called "no load mutual funds." When you invest, you'll want to focus on no load mutual funds. If you assume for a moment that mutual funds average returns of about seven percent per year, you begin to appreciate that paying a seven percent load would be like giving up a year's return. And for what? There is no historical evidence to suggest that load funds perform better than no load funds. Bear in mind that no load funds do charge other fees and expenses.
Redemption Fees
: Some funds charge fees when you sell your shares if you sell them too soon. These fees may be charged for mutual fund sales up to five years in the future. Not all mutual funds charge redemption fees. Even many no-load mutual funds do not charge redemption fees.
12b-1 Fees: Marketing and distribution expenses are customarily labeled 12b-1 fees; they are a special class of fees defined by a section of SEC Rules. Many mutual funds do not charge 12b-1 fees.
Management Fees
: All mutual funds charge management fees. Fees vary widely from fund to fund. Funds that seek to beat market returns are often called actively managed funds; these funds tend to charge more. Funds that seek to match the return of a market index are called index funds. They can match market returns more easily because they simply buy a basket of stocks (or bonds) that represent the index well. The composition of most indexes changes infrequently so little management of index funds is required and their costs are much lower. Since most funds don't beat the market consistently and those that try have higher fees, buying index funds with low expense ratios seems a good bet.
Other Fees and Expenses
: Mutual funds may charge you a variety of fees and expenses, but all must be disclosed before you make your purchase.
It is impossible to predict accurately the returns you'll earn on a mutual fund investment. It is relatively easy to predict the fees. By focusing on reducing fees, you are likely to increase your returns. If you have a question about a particular fund, you can check the fees and expenses using this tool from the regulator FINRA.
