On a very regular basis, I will sit down with a potential new client who brings their account statements into the meeting, which typically are full of managed mutual funds. These mutual funds have an assortment of fees attached to them that we can see, but sometimes they are disguised hidden deep in something called “statement of additional information”, which is a document mutual fund companies make available upon request but don’t generally distribute to investors.

The most obvious fee attached to a mutual fund is the expense ratio. The expense ratio is typically not hard to find and ranges from about .07% to 2.65% which sounds very high, and it is! I did not realize that there were still mutual funds that had that kind of expense ratio, but I witnessed one yesterday in a new client account that his “investment representative” from a local bank brokerage placed in his account. Brokerage and wealth management arrangements inside of banks are a topic for another article, just be aware in many cases the brokers are not bank employees. They often just have commission splitting arrangements with the bank. Selling product is their goal, not advice delivered in a fiduciary capacity.

So why is it that it seems the client never really makes superior returns in these mutual funds? Another key statistic to look at regarding your mutual fund is the turnover ratio. The turnover ratio is simply the amount of times that stock, or bonds are bought and sold which leads to increased operating costs and tax ramifications if this fund is not in a tax qualified account. These transaction costs lead to roughly 1.44% additional expense in the typical mutual fund. Cash drag is simply a term used to explain an additional .83% of expense per year in a mutual fund according to Ty Bernicke, CFP. This cash is not used for tactical purposes, but only for liquidity in funds that must carry adequate cash for investor outflows.

All mutual funds carry these additional hidden expenses to some degree, however low-cost index funds fees are typically much lower.

Broker sold funds may also carry a load or commission that you must consider as well. Usually “A” shares have an upfront commission somewhere around 5%, so only 95% of your money is invested and is subject to these additional ongoing fees. C shares usually don’t have an upfront commission but have a very high expense ratio of which approximately 1% annually goes back to the broker as a trail commission.

I don’t know many circumstances when you would not do better for yourself and your money to use low-cost mutual or exchange traded funds. If you wanted help you can hire an advisor on a fee basis to manage these funds. Make sure that the advisor you hire is working for you with a fiduciary duty and makes their fee structure very transparent.

If you would like to discuss this topic or anything else, give my office a call or send me an email.