Investing in mutual funds is a wonderful way to grow your investments, but all the fees associated with such investments them can be a financial drain. Learning about these expenses and how to reduce or eliminate them is a relatively easy way to increase your returns. Taking the time to mark smart decisions and plan out your retirement investments will relieve a great deal of stress later.
Diversify with mutual funds
Mutual funds are essentially broad collections of stocks, bonds, and/or other securities that you can buy into as a pool. Buying individual stocks instead of a diversified mutual fund can cost quite a bit of money, and also exposes you to risks associated with poor diversification. Thus, many people include mutual funds in their retirement portfolio.
There are a tremendous number of mutual funds out there, each with different investing goals and styles. Index funds are an increasingly popular type of mutual fund because they invest in whole sectors or markets, and can provide an broad diversification while minimizing costs. This broad diversification reduces specific (or “unsystematic”) risk associated with individual securities. Diversity is good because it can reduce risk by not having all your investment eggs in one basket.
While mutual funds can be an economical way of investing, you still have to keep your eye on the fees.
Mutual fund loads
Loaded mutual funds are simply mutual funds with an extra sales cost added. This fee can be tacked on at the initial sale (front-end load) or when you liquidate (back-end load). Mutual fund loads are basically a sales commission, and typically run around 4-6%.
Do they offer a real benefit for you as an investor? I would say the answer is no, as there’s no good evidence that funds with sales loads outperform those without. If you invest $10, 000 for a front load mutual fund, $500 would be taken for the commission, leaving $9, 500 to invest. That might not sound like much, but as compound interest grows through the decades, you’ll have a lot of ground to make up.
I should also mention that some mutual funds with back loads can include a contingent deferred sales load. In other words, if an investor holds the fund for a certain amount of years, the commission decreases to 0%. If you’re a buy and hold type of investor, this can make a big difference, though I would still shy away from any fund with an associated sales load.
Over at Fool.com, I ran across some candid remarks on load funds and no-load funds:
…there is no real difference historically between the performance of load funds and no-load funds in terms of year-to-year performance. In fact, according to the latest survey by the mutual fund data analyzer Morningstar, even excluding the drag on returns if the load were included in the calculation, no-load funds actually have a superior record to load funds over the last 3-year and 5-year periods.
The bottom line is that, if you’re looking to invest in mutual funds, you should look for funds with no sales commission tacked on. There may, however, be other fees associated with it, so don’t let your guard down.
Yahoo! Finance has a mutual fund screener that can help you find some good no-load mutual funds relatively quickly. There are also a number of well known mutual fund families that offer no-load mutual funds. A few of my favorite sources are:
In order to pay for the marketing and management costs of a mutual fund, you will also be charged an expense ratio. An expense ratio is usually calculated as a small percentage of your holdings. In general, you’re looking for the lowest expense ratio possible for a given fund type. In many cases, index mutual funds offer both low expense ratios and historically solid returns. A big reason for this two-fold benefit is that index funds do not require a management team to decide where to invest your money. Instead, your fund simply tracks a broad market index. This sort of automation results in cost savings that are (hopefully) passed on to you.
While there are certain unavoidable costs associated with investing, many of these costs can be avoided, or at least minimized. You may have to do a bit of legwork to learn about your options, but the benefits are big. In general, I would pass on on expensive (and often loaded) mutual funds in favor of low-cost index funds.
How about you? What sorts of investments are in your portfolio?