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Investing in Mutual Funds: The True Cost

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Mutual funds have long been the go-to investment for the average investor.  In fact, the majority of retirement savings held in 401k, 403b, and other work-sponsored plans are held in mutual funds.  Considering the tremendous amount of wealth in mutual funds, it would seem that investors must know the costs of the funds they own.  Unfortunately, most don’t.

While mutual funds can be an appropriate investment, knowing the costs of the investment is critical.  After all, the cost of the investment has a direct impact on the long-term return.  In an effort to help investors learn about the costs of mutual funds, we’ve broken down the main fees below:

  • “Load” funds versus “no-load” funds:  the term load is another word for a sales commission or sales charge.  Mutual fund companies use loads to compensate financial advisors or sales professionals for the service and advice provided to investors.  Loads may be paid up front, in the form of “A” shares, or as a back-end charge, also known as a “C” share.  “No-load” funds usually do not charge a front end or back end load, but it is important to note that they are not “free”.
  • Expense ratio:  the expense ratio of a fund is the percentage cost mutual funds generate in the operating and administration of the fund, including the wages of the mutual fund managers and back-end 12-b1 fees.  The expense ratio is a separate cost from the load expense explained in the first bullet point.  Expense ratios range from as low as .2% to above 2%, and are dependent on a variety of factors, including the type of fund and the activity level of the managers.
  • Transaction costs:  transaction costs are the most difficult cost to determine on an on-going basis as they are constantly changing.  Transaction costs include brokerage commissions paid by mutual funds to trade stocks or bonds on the exchanges, the costs associated with impacting the securities prices on open markets through large trades, and the cost of the spread between bid and ask prices when mutual funds place trades.  Mutual funds do the best they can to reduce these fees, but they’re an unavoidable part of the cost of managing assets.

Have you analyzed your costs recently?  We encourage you to evaluate your portfolio frequently and take an active management approach to minimizing costs.  We’re here to help and have tools to offer.  To get started on your own, visit http://apps.finra.org/fundanalyzer/1/fa.aspx and utilize FINRA’s Fund Analyzer tool.

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