How Fund Investors Pay...and Pay

When you buy individual stocks, you expect to pay a broker commission, so it may seem to make sense that you do the same when you buy shares in a mutual fund. Many fund investors do just that, buying funds through brokers who often get a percentage of the amount of your investment. The money to pay the brokers comes from fees like a front-end load, which you pay when you buy the shares. Some funds have a back-end load, which kicks in when you redeem your shares, and a more subtle charge is the 12B-1 fee, which gets tucked into the fund’s expense ratio.

It turns out that these fees add up to serious money. According to research done a few years ago, the price tag on these three fees, which are essentially sales charges, totaled $23.8 billion a year. The effect of the fees on your investment results can be significant, too, say Wall Street gurus. To turn a profit for you, the fund must perform well enough to overcome the amount paid out in sales fees. A fund with a front-end load of 5%, for example, has to go up by that much before you get to break-even.

If a fund does outperform its peers, of course, it might be worth the extra cost. According to a recent report from Standard and Poor’s, however, only three out of 10 actively managed large-cap funds managed to beat the S&P 500 index over a five-year period ending in mid-2008. One reason that so many actively managed funds failed to beat the S&P 500 may lie in the fact that the average expense ratio for a managed fund ranges between 1.5% and 2%. In contrast, an index fund may charge as little as 0.2%.