Mutual Fund Fees - What They Won't Tell You About the Fine Print

In the first article in this series we learned about index funds versus actively managed funds.

Index funds, which are setup to track a market index, don't cost much for mutual funds companies to run. Another way to describe index investing is “passive” investing. And just as it sounds, "passive" investment is less expensive than “active” investment.

Management Fees: When you buy an actively managed fund, what you’re buying is someone’s time and expertise to make ongoing, active investment decisions – actually, the time and expertise of a lot of people. In addition to the head portfolio manager(s), there are teams of research analysts who research individual investment opportunities for the fund. All of these people need to be paid, and most of the time their work leads to investment decisions that don’t beat the market. But no matter what the results (whether they beat the market or not), you still pay the management fees. And the more money you have, the more you pay for exactly the same services because the fees are based on a percentage of the amount you’ve invested. It’s a great deal for the fund companies – if your investment goes up, so do the fees they collect; and if it goes down, they still get to collect fees on whatever remains. It’s a win-win scenario for the companies… I bet you know what that means for you!

Here's the important part, because actively managed funds are expensive to run and don't beat the market over the long-term, you, the investor, always loses.

Distribution Fees: With over 10,000 mutual funds available, you don’t have time to learn about each one before deciding which one to buy. Fund companies know this, so in addition to all the people who work on making investment decisions, there’s another team of people who work on marketing and explaining to you why their actively managed fund is better than everyone else’s. All of these people need to be paid as well, and if they successfully convince you to buy their fund it still won’t beat the market most of the time. These people include your broker if you invest through a traditional brokerage (of which there are hundreds, ranging from giant firms like Merrill Lynch to regional firms like Raymond James and Edward Jones and smaller local shops). Guess what? That’s right – the broker needs to be paid, too.

So you’ve got management fees for the portfolio managers and their teams and then you’ve got distribution fees. That’s a lot of fees and there are still other expenses. Without going into detail about all the rest of the possible fees, and there are a lot more of them, it’s already enough to know that management and distribution fees alone make it pretty hard for most active managers to beat the market.