Many investors have heard of mutual funds, but few understand how these funds work, and this is not surprising as most people are not financial experts. However, investors can make better decisions if they knew that mutual fund companies make money by charging them fees. Mutual funds make money by sales charges that work like commissions as well as by charging investors a percentage of assets under management.
The Securities and Exchange Commission (SEC) asks a fund company to disclose shareholder fees and operating expenses in its fund description.
Therefore, Investors can find this information in the fee table located near the front of the prospectus. Fees are easily the largest revenue source for primary mutual fund companies; however, some organizations may make separate investments of their own. Different fees include purchase fees, sales charges, mutual fund load; deferred sales charges; redemption fees; account fees; and exchange fees.
It has to be mentioned that mutual fund is among the most popular and successful investment vehicles as they are flexible, low cost and the change for high returns is high. Besides, investing in a mutual fund is different from packing money into a savings account or a deposit certificate (CD) at a bank. While investing in a mutual fund, the investor is buying shares of stock in a company.
Fund companies can attach various fees to their services and products, but where and how those fees are combined makes a difference. More commonly referred to as loads, sales charge fees are triggered by an investor’s purchase of mutual fund shares, which indicates the investor spends an extra percentage, about 5% usually.
However, it has to be mentioned that there are various kinds of fund loads and the most popular is the front-end load. It is immediately deducted from the investment amount before the shares are bought.
Significantly, the Financial Industry Regulatory Authority sets an 8.5% cap on front-end loads. For instance, a $1,000 investment with a front-end load sends $50 to the broker and $950 to buy shares of the mutual fund.
Additionally, there are also back-end loads that can be chargedwhen the shares are traded, and the most popular of these is named the contingent deferred sales charge. This load starts relatively high and is inclined to decline over time, usually falling to zero after 7-10 years.
Moreover, management fees are highly dependent on the success of the fund. The most successful funds witness much money and tend to be highly liquid as more trading means more fee income.
Annual Fund Operating Expenses
Furthermore, Mutual fund companies do not operate for free, and some expenses need to be recouped. This money covers the expenses for investment advisors, fund research analysts, administrative staff, distribution fees, and other operating costs.
Additionally, it has to be mentioned that management fees are not charged directly to the shareholders and are paid out of the mutual fund’s assets. Besides, SEC requires management fees to be listed as a separate item and not with the other expenses category; therefore, investors can always be aware of which funds are spending the most on management compensation.
Additionally, most investors hear about distribution fees, which are often called 12b-1 fees and capped at 1% of fund assets. They are charged to shareholders to pay costs associated with marketing the fund and providing shareholders services. Besides, these fund costs are necessary; for instance, the SEC asks the printing and distribution of prospectuses to new investors. We know that mutual fund space has become more competitive. Hence, 12b-1 fees have narrowed, and shareholders have become more sensitive to them.
Some mutual funds do not have sales charged, which is knownas no-load funds. However, it does not mean they are free of fees. They still recoup expenses of marketing and distribution (12b-1 fees). However, SEC does not allow these companies to refer to themselves as no-load if distribution expenses top 0.25%. Furthermore, other funds, for example, the Vanguard family of funds, do not have sales charged or distribution fees.
Those funds can still earn revenue from other kinds of fee income; however, no-load funds are inclined to reduce costs to compensate for the lack of sales charge income..