Have you ever wondered where your x% management fee goes every year with your mutual fund?
Mutual fund fees are broken down into three basic categories, also known as calculating the expense ratio, which is the total cost to run the mutual fund each year. If you have ever heard of the term MER, that stands for "management expense ratio" which is the same as the expense ratio.
Expense Ratio Broken Down:
- The cost of fund managers. This is typically referred to as the management fee and runs between .5% and 1% of the total assets. The big catch with mutual funds is that you pay your management fee regardless of how well the fund performs. Consider a mutual fund with a size of $1 billion (which for mutual funds isn't that large), with a 1% management fee the managers are making a cool $10 million that year. Again, regardless of the funds performance.
- Administrative costs. These vary depending on the fund but really can get out of hand. Including are expenses of postage, customer service, office equipment, etc. Some funds do a very good job at keeping this cost as low as possible, but on the other hand some funds don't mind charging customers for their space aged water coolers and desks.
- 12B-1 Fee. Not all funds have this, but the ones that do charge this fee as a way to funnel money into marketing and brokerage commissions. If you ever see commercials or online ads for your mutual fund, know that you are paying for them each and ever year with your hard earned money when it could be appreciating in the market.
On average expense ratios will vary anywhere from as high as 2% to as low as 0.2%. If you are paying .2% it is more than likely because you are investing in a index fund which you could do for free by simply buying an exchange traded fund (ETF).
I will close the article with this fact, just about every study ever done has shown no correlation between high expense ratios and high returns. 9 times out of 10 paying a high expense ratio will not be your ticket to higher returns.