Michael Carlin

Hi this is Michael Cohen president of Henry Norton wealth management here with your manage the funds podcast. We have to do a how to understand expenses in mutual funds. We have to, because no one seems to know. Recently I was talking to a client of ours that’s a lawyer and I asked him. We’re talking about his retirement plan and the company and I said So what do you figure the expenses are inside your retirement plan. You know the mutual funds said what you mean like you know that the fund expenses.

So I have no idea. And it doesn’t stop surprising me that people don’t know it doesn’t matter what your profession is people just don’t know what the mutual fund expenses are. And I don’t care if your money is at Vanguard Fidelity American funds to zero price. JOHN HANCOCK I don’t. I don’t care a mutual fund has an expense to it. They’re not free. And you know they’re not free because Vanguard Fidelity have huge buildings and employees. They’re huge companies they sponsor things. Where do they get the money from.

They get the money from mutual fund expense slits. Let’s unpack a little bit about what’s inside these mutual funds and what’s inside these expenses. Because when you’re looking at your statement it’s not obvious. When you grab your statement. And you flip front and back. You might find some disclosures but you’re not going to find in there. Oh well here are the fees. The good news is you can go online and find them easy enough. But first you need to start with what am I looking for.

There’s a bunch of different costs inside of mutual funds. Let’s break them down. We’ll talk about what they are investment management fees asset wrap fees sub TAFE fees in shareholder servicing fees. And there’s two more extra hidden costs that I’m going to save for the end that you probably didn’t even know existed. Let’s unpack that. Let’s unpack the expenses one at a time. The first is a management fee. Management fee is what goes to the portfolio manager. So you need to understand your mutual fund expenses you know understand your management fees it doesn’t an expensive fee does not always mean performance.

Also understand that the mutual funds can raise and lower their expense ratios from year to year. They’re not locked in. They tend to hover around the same amount but you got to be careful. You got to look at that data. Then there’s two different types of funds. There is the actively managed funds like the Super Fund where they’re investing in futures and trying to trying to get you in the right place in the right investments at the right time and in their passive funds. Think of Vanguard as an example.

Those funds that are not active that just passively own a variety of different investments that are stagnant. Tend to charge a lot less. There are a bunch of Vanguard funds that charge five basis points four basis points or four one hundredths of one percent. Scot free. It’s still a number. You got to know your expenses again. Let’s go to 12 B1 fees so we’re break we got through margin fees get to twelve B1 fees. Now the 12 one fees is typically the fee that’s used to reward an intermediary for promoting a fund.

In other words. It’s a lot like a commission. Meaning if an adviser. Puts you into a mutual fund that has a 12 B 1 fee in lots of cases and in most cases I should say that adviser will be paid the 12 B1 fee. It does feel like a commission. So if you’re ever wondering. How your adviser charges you when you’re just holding these mutual funds if your mutual fund is it’s wealthy one fee you might have just answered your question. That may be how they’re getting paid. If you have a fee only investment adviser they’re not receiving your twelve B1 fees came in so you need those fee based advisor is is not keeping it but a commission based advisor or a broker is you need to know the difference between that two.

Will be one fees aren’t necessarily the most the most expensive part of the equation but typically the average somewhere around that 13 basis points or 13 one hundredths of 1 percent. So if you have ten thousand dollars in a mutual fund that’s about 13 bucks a year. We just want you to know what it is where it goes and what to look for. Some each of funds have a redemption fee. And that may surprise some people. It can come in the form of. You buy a fund in that you won’t pay a fee.

Unless you sell within the first 90 days. Wow. How did that come up or in the first year. There’s all different kinds of fund type redemption fees that exist. You need to know before you buy it if it’s recommended to you by it on your own. Is there a redemption fees if there is what is it. Don’t get yourself into a mutual fund without knowing that information first because you may buy it and then decide you want to sell it over some period of time and you don’t we’ll be paying a 1 or 2 percent fee to get out.

By the way the FCC mandates that you can’t have a redemption fee greater than 2 percent. This fee does not go to the broker. This actually goes back to the mutual fund. Then you have different fees that hopefully you don’t see a whole lot of anymore. But this used to be the only way mutual funds were sold. When I first started in the business mutual funds there were no options it was just you bought a mutual fund and you paid an upfront charge upfront sales load in the upfront load. When I first started was eight point seventy five percent right.

So for every ten thousand dollars you put in eight hundred and seventy five dollars came right off the top. And paid the broker. That’s the way it used to be. Now there’s a whole bunch of different other kind of upfront back end and in level load situations where it’s a B and C share class. There’s a lot of different share classes with mutual funds for the purposes of this how to understand if you’re buying a share in a commission based environment. You’re going to pay an upfront fee. Could be as high as five point seventy five percent.

If you’re going to buy a B share it’s a backend fee it’s a fee that will decline over time but if you keep the mutual fund likely for years before you can liquidate the fund without a fee. A C share is a level load frontier charges you a 1 percent fee per year every year for however long you hold the fund you got to understand this before you buy a fund. You’ve got to ask if you’re if you’re going to be buying a fund like this ask your visor for paying a load. There are you know there are a lot of different ways to do this.

The advice that we typically give clients is we don’t want you paying sales loans we want you to be buying these. Free of charge to get in no charge to get out. There’s too many different options these days that the old way of doing business is something we tend to recommend clients steer away from. Let’s get to some hidden fees they are too ready then hit no one hidden fee transaction fees.

Quite so. University California Davis professor Roger Edelman in his car research from the University co researchers from University of Virginia.

They analyzed portfolio holdings in transaction data for about seventeen hundred funds from 1995 through 2006. What they found is that the cost that mutual funds paid to buy and sell the stocks in their portfolio. Could be as high or higher than the expense ratio of the fund that’s the first thing that’s again. That part of that management fee. What they found is that fees can vary by asset class for example investors in a small cap fund they can pay an average of 3 percent or more in transaction costs in large cap value funds could pay.

Point 8 4 percent. Or 84 basis points per year. It’s a hidden cost. Now that you won’t see in the prospectus that information you won’t find anywhere. Other than here of course. So understand that there’s a hidden fee. For the cost to buy and sell stocks in the portfolio. So one of the things you’re going to look at is the portfolio turnover. How often are the stocks being rotated in my portfolio. There’s a lot of rotation then you’re going to know there’s a lot of transaction costs hidden fees number two.

Taxes. Mutual funds can be inefficient when it comes to taxes. And what you have to know is that there’s a whole bunch of holdings inside your mutual fund a whole bunch of different stocks. And when you buy that mutual fund you inherit. The original cost that that mutual fund purchased the shares at. And if you’re looking at a mutual fund that has good performance then they probably bought good stocks and they probably did it a long time ago and there’s probably in some cases a bunch of gains in the portfolio and you’re inheriting that mutual funds cost.

With which they acquired the stock. There are environments where your mutual fund that you bought could lose money and yet distribute a taxable gain to you. Because of the transaction activity inside the fund because they may have owned stocks bottom a long time ago sold them out again even though the fund lost money and distributed the shareholders again. I know I think great unknown fee. Number two is the tax. And the tax nature of mutual funds have got to be careful they’re not as straightforward as many people believe. So now you know.

What the expenses aren’t out of mutual funds you know they’re not free. You know that you won’t find an honest statement. You know that you can go online. Put the ticker symbol and put the name of that fund. Go to Morningstar your favorite different your favorite Web site to find these kind of things and you’ll be able to locate exactly what the expense ratio is. A good knowledgeable investor is a better investor. So with that. That wraps up your Henry+Horne Manage the Funds Podcast. I’m Michael Carlin.

Thanks so much. Take care. Have a great day.

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