Investment Basics - Fees

Relief association trustees should be aware of the different types of fees that investment securities may be subject to before purchasing an investment. Investment fees can make up a significant portion of a portfolio’s annual return, and they can add to even bigger investment losses during difficult financial cycles. Trustees should look for investments and financial institutions that try to limit fees passed along to the investor. With good research, relief associations can find investments and financial services companies that charge low fees but still offer comparable or even better services than their counterparts that charge higher fees. Relief associations can also purchase shares in mutual funds directly from the mutual fund company. Relief association trustees should ask their brokers to explain the fees that are included in current and prospective investments. Some typical investment fees that a relief association may see are listed below.

Wrap Account Fees

The wrap account fee is a flat fee that covers money management, broker advice, brokerage firm support, and trading. The fees for these types of accounts typically range from one percent to three percent of the total value of the investments. Inside a wrap account, investments can be bought and sold without having to pay the transaction fees. This may not benefit the average investor who buys and holds investments or is involved in limited trading. There are also mutual fund wrap accounts where the money manager invests assets in a diversified mix of mutual funds. Fees for mutual fund wrap accounts generally range from one percent to 1.5 percent of the total investment value. Additional operating expenses may also be charged.

Investment Management/Advisory Fees

Investment management and advisory fees are charged as a percentage of the assets being managed for a particular investor by a particular investment firm. These fees are charged for handling the investor’s account and giving financial advice. For example, a one percent management fee on a $10,000 investment is $100.

Transaction Fees

A transaction fee is charged when a broker buys or sells a stock or mutual fund for an investor. These fees are flat fees and can range from $7 to over $50, depending on the investment firm.

Annual Account Fee/Custodian Fee

Annual account and custodian fees can be charged by mutual funds and by brokerage firms. These fees can reach $100 per year.

Mutual Fund Expense Ratios

The expense ratio reflects the cost of owning a mutual fund, and the operating expenses that mutual funds charge investors. This ratio covers the operating expenses, investment advisory fees, administrative costs, and the 12b-1 distribution fees for certain mutual funds. Mutual funds incur transaction expenses every time the fund buys and sells stocks or bonds within the mutual fund. These expenses are passed along to investors. The expenses paid by a mutual fund can be determined by analyzing the expense ratio.

The expense ratio is not deducted from the investor’s account; rather the investment return that is reported to the investor for the year is net of these fees. For $1,000 invested, an expense ratio of 0.90 percent means that $9 per year will go toward expenses. The lower the expense ratio for a mutual fund, the lower the fees will be. Index funds generally have the lowest expense ratios, because activity within the fund is limited. Index funds have expense ratios that typically range from 0.18 to 0.50 percent. In contrast, actively-managed mutual funds often have expense ratios around 1.5 percent. The expense ratio does not include the cost of buying a mutual fund through a broker. The expense ratio fees apply to the management of the mutual fund and are charged by the mutual fund company itself.

“Load” vs. “No-Load” Mutual Funds

• “Front-end load mutual funds” charge a fee based on a percentage of the initial amount invested in the mutual fund. These fees are in addition to the operating expenses of the mutual fund. For example, if you purchase $1,000 of a five percent front-end load mutual fund, the amount deducted when your money is initially invested in that particular mutual fund is $50. The initial amount that is actually invested is $950 as opposed to $1,000.
• “No-Load mutual funds” do not charge an initial fee to purchase shares of the mutual fund and do not charge a percentage of the total amount when the shares are eventually sold. No- load mutual funds are still subject to the annual operating expenses of the mutual fund.
• “Back-end load mutual funds” charge a percentage fee when the mutual fund shares are sold. This fee can be as high as five percent, and is based on the total amount for which the mutual fund shares were sold. The fee oftentimes is reduced by the length of time that the mutual fund was held. For example, if a mutual fund was only held for one year, a five percent fee may be applied, whereas a three percent fee may be applied if the mutual fund shares were held for three years. This back-end fee is in addition to the annual operating expenses of the mutual fund.

Published last in the April 2009 Pension Newsletter