Mutual Fund Fees and Expenses
The mutual fund expense ratio is the primary reason the self directed investor should invest in stocks and ETFs, but not mutual funds. Keeping expenses low should be one of the primary goals of investment management. Mutual Funds carry layers of expenses that greatly reduce portfolio returns. Being able to avoid mutual fund fees and expenses is one the benefits of self-directed investing.
The mutual fund expense ratio is the percentage of a portfolios assets that go towards managing, administering, and in the case of some mutual funds, advertising the fund. These expenses are deducted from the fund regardless of whether the portfolio has profits or losses. There are 3 different types of expenses that make up the expense ratio.
Mutual Fund Management Fee or Investment Advisory Fee
The mutual fund management fee or investment advisory fee (average 0.5% – 1.0%) is used to compensate the managers of the portfolio. The administrative costs are the expenses of running the fund. This would include record keeping, customer service, mailing communications, etc. These costs can very greatly when expressed as a percentage of fund assets. The last and most controversial fee is called the 12b-1 distribution fee that is collected for advertising and promoting the fund. Yes, many mutual funds charge their shareholders to market and promote their fund.
These three fees make up the percentage of assets deducted annually from a fund and is referred to as the expense ratio. The average mutual expense ratio is about 1.4% of assets. How does this affect investment returns?
The empirical evidence is that high expense ratios lower investment returns. In other words, the argument made by some money managers that higher expenses provide better management and higher returns is unsubstantiated.
In general, investors should try to avoid the high cost of mutual funds and use stocks and ETFs to keep expenses low. If the average long term equity portfolio returns 8% annually a 100,000 portfolio will be worth $466,000 in 20 years. Look what happens if you lose 1% of that gain because of higher expenses. A $100,000 portfolio that returns only 7% is worth only $387,000 in 20 years.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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