Invisible Fees In Mutual Funds

By |2017-10-24T07:23:11+00:00April 7th, 2016|Investing|

Transparency in the financial world has traditionally been lacking. As information sources have increased, along with it has come more chances to look behind the curtain. The mutual fund industry in America is huge, most all Americans have or currently do use these products for accumulating funds for retirement and many other uses.

Mutual funds are a collection of assets ranging from stocks, bonds, real estate (REITS) and other asset classes. To make the funds operate, fees and expenses must be charge or assessed. When a mutual fund is purchased a prospectus of the fund (disclosure) and its goals are always included in sales process. In the prospectus is a full disclosure of fees and expenses, however many who buy mutual funds rarely understand all of them.

The cost to acquire the fund (loads) and the cost to run the fund (expense ratio) are easily understood by most mutual fund owners. What is rarely understood is how the fund buys and sell the assets in the fund. These are known as the “invisible” fees.

The amount of buying and selling during a year is calculated and disclosed in a term known as “turnover” ratio. This term refers to the percentage of assets that are sold or assets purchased during the year. The amount of turnover ratios greatly with the type of mutual fund. Funds that are actively managed would tend to have a higher turnover ratio as the fund managers are attempting to increase the yield on the overall fund. The opposite would also probably be true, fund passively managed would tend to have a lower turnover ratio.

Why is this important? It is important for two reasons, when an asset is sold, a potential taxable event could occur. The second reason is this: every time an asset is bought or sold a sales expense is incurred. This expense is prior to the calculation of the expense ratio and is in addition to the expense ratio.

While it is difficult to actually know what this expense really is, common sense would dictate that a lower turnover ratio would translate to lower acquisition and selling expenses. This expense is known as the “invisible” expense, few know about it and almost no one knows what the actual expense of it is in any specific mutual fund.

It simply is not disclosed, why? It is not disclosed because the SEC does not require it to be disclosed. An article in US News and World Report said this about the undisclosed hidden fee:

Transaction costs. A 2007 study by Edelen, Evans and Kadlec found U.S. stock mutual funds have an average transaction cost of 1.44 percent per year, which is not included in the expense ratio. These fees are not found in most prospectuses and can be difficult to determine.

http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2015/03/04/the-mutual-fund-fees-we-dont-talk-about

Barron’s, in a 2013 article further quoted Professor Roger Edelen (professor of finance, UC Davis) about fees for asset acquisition:

http://www.barrons.com/articles/SB50001424052748704356104578326293404837234

If you invest in mutual funds (as 53.2 million Americans do, 43% of all American households) ask the right questions before you make any final decision.

  • What is the expense ratio of the fund? (cost of running the fund)
  • What are the costs to acquire the fund? (loads)
  • Ask your broker what the turnover ratio is on the recommended mutual fund. (buy and sell assets)
  • Is it tax efficient?
  • What would be their estimate of acquisition fees?

Most brokers may not have a clue about acquisition fees, but by asking you show yourself as a knowledgeable investor. Read the prospectus and ask questions. Many mutual fund prospectuses can be hundreds of pages long, ask for the summary of the prospectus and ask questions from there.

The secret to good mutual fund decisions is based on knowledge, knowledge derived from transparency.

Disclaimer: the author of this article is NOT security licensed and not authorized to sell securities or give investment advice. The author is a fixed annuity salesman and licensed via state of residence.

 

About the Author:

Bill Broich
Bill Broich is a well-known annuity expert with over 30 years of experience. He has written hundreds of articles on annuities and other financial topics, and has been a featured commentator on TV, Radio and the Internet. To follow Bill's profile, click here.