Based on an informal poll over the years of family and friends who invest in mutual funds, about half believe they don’t pay any fees to buy and own mutual funds. I have a message for them: you’re mistaken. There is no such thing as mutual funds without fees. The fees you pay have been hidden from you.
There are rules about disclosing mutual fund fees, but financial advisors can follow the letter of the law without their clients actually understanding what fees they pay. The fees are explained in a document called a prospectus that is supposed to be given to clients, but even a simplified prospectus is long enough and complex enough that few clients read it.
All mutual funds have expenses. Most of the ongoing expenses to run a fund are components of the Management Expense Ratio (MER). This is expressed as a percentage, such as 2%. This means that 2% of your money comes out of the fund every year to pay costs including salaries of the fund managers, payments to your financial advisor, and other costs.
A cost of 2% each year may not seem like much, but another 2% of the same money will be taken out again next year and the year after that. The math says that it will take about 35 years for half of your money to disappear.
You’d think that your mutual fund statements would have a line showing the amount of the MER being deducted from your money, but this is usually not the case. The money evaporates silently in most cases.
Another category of fees are loads. Depending on the type of mutual fund, you may pay some type of load:
Front-end load: This is where a percentage of your money is removed before the money goes into the mutual fund.
Back-end load (Also called a deferred sales charge (DSC)): This is where a percentage of your money is deducted before you get your withdrawal from a fund. This type of load is popular among advisors and many of their clients don’t understand how it works until it comes time to make a withdrawal.
There are some good financial advisors out there who properly explain these fees to their clients. It’s unrealistic to expect people to work for you for nothing. But you should understand what you are paying. If you own mutual funds and thought there were no fees, maybe your advisor isn’t the great person you thought he or she was. You thought the two of you were a professional and a client, but maybe you’re a salesperson and a mark.