The expense ratio of mutual fund

One handy way to measure the relative cost of investing in a particular fund is by looking at its expense ratio. This figure, which appears in the fee table section of the fund’s prospectus , is the amount that each investor can expect to pay for fund expenses each year, stated as a percentage of the money invested.
The expense ratio includes administrative costs and management fees but not sales charges (loads) or 12b-1 fees, which I explain in the following sections. Thus, the expense ratio provides you with a useful, though partial, picture of the costs involved in investing in a fund.
The average stock fund has an expense ratio of about 1.4%; for bond funds, the average is under 1.0%. A ratio higher than this may or may not be justifiable, depending on the kind of fund you are considering.

Administrative costs of mutual funds

Administrative costs may include a variety of expenses. Shareholder service fees, sometimes referred to as transfer agent service fees, are typical administrative costs. The transfer agent maintains records of your ownership of the fund’s shares. When you open an account, the transfer agent records that transaction. If you transfer money into or out of the fund, the agent records this activity. The agent also handles your redemption requests when you want to cash in all or part of your investment. And if the fund company distributes dividends or capital gains to investors, the transfer agent records that transaction.
Mutual fund companies offer other shareholder services, the cost of which is included in the same set of fees. When you call the fund company to set up an account, you talk to a representative; similarly, when you request information about a fund or receive an annual report in the mail, a fund employee must handle these services. Such expenses also come out of shareholder service fees.
Custodial fees are another type of fee included in the annual operating expenses listed in a fund’s prospectus. When you invest in a mutual fund, you’re buying stocks or bonds that must be handled by a third party — a custodian. The custodian holds the stock for you, provides ownership records to the mutual fund company, and handles various kinds of internal paperwork.
The custodian also tracks the action if a particular stock splits — that is, if the company issuing the stock decides to convert (say) 100 shares trading at $120 per share into 200 shares trading at $60 per share. (Companies sometimes do this in order to keep their per-share price fairly low and affordable.) The custodian handles the administrative work caused by stock splits.
For most domestic funds, custodial fees are usually not high. For funds that invest in foreign stocks, custodial fees can be substantial because of the complications of investing in foreign countries.

Management Fees of Mutual Funds

Management fees cover the fund company’s management expenses — the work of lawyers and accountants, the cost of maintaining books and records, money spent complying with government regulations and disclosure rules, research expenses, and the salary of the fund manager, among other costs. The amount varies from fund to fund and from one type of fund to another.
Management fees are usually lower on money market mutual funds and other bond funds and higher on most types of equity funds because of the greater complexity of the investment decisions.
Management fees are usually the single largest portion of a fund’s annual expenses, averaging between 0.5% and 1.0% of the fund’s assets.

Annual Operating Expenses of Mutual Funds

Of course, (almost) no good thing is free. All mutual funds have associated expenses — even no-load funds. Before choosing any fund, learn about the costs you can expect to pay for the investment expertise and services the fund provides.
You can find the annual operating expenses of any fund described and estimated in the fund’s prospectus. These expenses may include management fees, administrative costs, and 12b-1 fees, all of which I explain in this chapter. These fees are generally deducted automatically from your account and shown when you receive your regular account statement in the mail, so you don’t have to worry about sending in a check.
Some funds are naturally more expensive to operate than others.
A fund that invests in international stocks or small company stocks tends to be more expensive than average, because research costs are likely to be higher in these areas. By contrast, an index fund that simply tracks the performance of a preselected bundle of stocks generally has lower expenses and therefore can save you money when you invest. However, the fact that a particular fund has relatively higher expenses need not deter you from investing in it. A high investment return may more than make up for the annual expenses charged.

Understanding no-load funds

A no-load fund charges no sales commission. Typically, the mutual fund firm that sponsors the fund is the investor’s source for this kind of fund. These firms often sponsor entire families of no-load funds, each with a different investment objective, philosophy, and style.
Some of the better-known mutual fund families, including T. Rowe Price, Fidelity, Janus, and Vanguard, offer a wide array of no-load funds, one of which is likely to be an appropriate and attractive investment for you.
When you invest in a no-load fund, you skip the middleman — the sales agent — and therefore save the money that would otherwise go to pay his commission. You don’t have to meet with or speak to a broker or salesperson; instead, you call the mutual fund company, ask for an application and informational brochures about their funds, and then send in a completed application form with your check. If you invest $1,000, the entire amount begins working for you, with no deduction for any load or commission.
Is there any significant downside to choosing a no-load fund? Not really. Some investors prefer load funds because they like having an ongoing relationship with a broker or other financial professional who can advise them from time to time. By contrast, with a no-load fund, the investor is on her own; she can call the fund company to make transactions or to request publications, but she can count on speaking to a different representative every time she calls. The investment performance of load and no-load funds is the subject of many research studies. In virtually every study, no significant difference is apparent. In other words, investors who paid sales commissions of 5% or more for load funds did not enjoy noticeably better investment results. Because you can invest your money with equal profit in either a load or a no-load fund, why not save some of your hardearned cash by considering only no-load funds for your portfolio?

Understanding redemption fees

Instead of up-front sales charges, some load funds charge a redemption fee. With this kind of load, you pay a fee when you cash out of the fund by selling your shares. The size of the redemption fee depends on the fund you are invested in; each fund has its own fee structure, often on a sliding scale, so that the redemption fee decreases the longer you hold the fund.
For example, a typical redemption fee structure provides that, if you redeem your mutual fund shares within a six-year window, you can expect to pay anywhere from 6% to 1% — 6% during the first year, 5% during the second year, and so on. The redemption fee drops off at the seventh year. (By design, the fee structure encourages you to hold on to your investment for a longer time, which benefits the fund company.) Carefully study the sales brochure or prospectus for any fund you’re thinking of investing in. Make sure you understand the nature, size, and structure of any load charge.
Some load funds impose up-front sales charges; others include redemption fees; others levy annual commissions for as long as you own the fund; and still others impose various combinations of these charges. Read the fine print so you won’t be blindsided by unanticipated expenses.