“That Investment Will Cost Me How Much?!?”
The first in a three part series on mutual funds.
Part I: The High Cost of Mutual Fund Investing
While few would say that saving money is a bad idea, it may surprise many investors how expensive it can be to save. Mutual fund companies, and investors that buy mutual funds, tend to focus on which funds have recently out-performed the market or have the best return relative to their peers. There’s unfortunately little discussion about costs, the drag fees have on mutual fund performance and the real costs to buy and hold a mutual fund long-term. Compounding this problem is the fact that most brokers/sales agents/bankers typically can’t or don’t want to explain fees, since their income is tied to the sale of the fund. The fact is, the cost of ownership can weigh heavily on a mutual fund’s overall performance and comes in the form of three distinct fees.
- Loads
- Expense Ratios
- 12b-1 Fees
Loads
In mutual fund jargon, a “load” is the commission you’re charged by a broker to purchase or sell a mutual fund. Mutual funds may carry a “front-load” (a charge to purchase), or a “back-end load” (a charge to sell). According to Morningstar (an investment research firm specializing in fund investing), the average commission paid by investors to purchase front-loaded mutual funds is 5.75% of their initial investment. That’s money that went to the mutual fund company before any of it was invested. These fees are used to pay the broker/agent their commission and to pay the broker/agent’s company for using that particular fund in a portfolio. Back-end loaded mutual funds have a tiered fee schedule if you sell the fund within a certain time frame (schedules and time frames vary by fund company).
Expense Ratios
Expense ratios are the annual costs associated with operating the mutual fund, including paying the people managing the fund and administrative costs. Morningstar’s research shows that the median average expense ratio for a front-loaded Large Cap mutual fund is 1.22%. The average expense ratio on Small-Cap and Developing Markets funds average 1.45% and 1.80% respectively.
12b-1 Fees
12b-1 fees are annual fees used to pay the broker/agent that sold you the fund for as long as you hold it, and to pay marketing and distribution costs. 12b-1 fees average .25% annually. Unlike “loads”, expense ratios and 12b-1 fees are ongoing, not one-time charges, and can vary from year to year based on the fund’s prospectus.
A Less Expensive Alternative to Mutual Funds: Exchange-traded Funds
When you look at the cost of owning a mutual fund, you may be surprised to see what you are actually paying and what those costs can do to the long-term performance of your portfolio. The high cost to investors is one reason Harmonic doesn’t use mutual funds to invest for its clients. To achieve the diversification and liquidity offered by mutual funds without paying the high costs, we use exchange Traded Funds (ETFs). Most ETFs track specific indexes, such as the S&P 500, Russell 2000 or Morgan Stanley’s Europe, Australasia and Far East (EAFE) Index. Importantly, there are no up-front or back-end “loads” or 12b-1 fees charged by exchange-traded funds. ETF’s do incur trade commissions and have expense ratios, but they are a fraction of what a comparative mutual fund would charge.
To get some real numbers behind these statistics, investors can use the Financial Industry Regulatory Authority’s (FINRA) Fund Analyzer, a free website that analyzes the expenses of over 18,000 stocks and ETF’s.
The site makes it easy to view an “apples-to-apples” comparison between a mutual fund and an ETF with similar investment goals. Below we’ve constructed a hypothetical scenario of investing $10,000 for 10 years; we’ve assumed an 8% average annualized return on both investments. FINRA’s Fund Analyzer combines the expense ratios and 12b-1 fees into a line item entitled Total Fees. The Total Sales Charges are the front-end loads.
Comparing an arbitrarily chosen Large Cap Blend mutual fund to a Large Cap ETF (AIM’s Large Cap Basic Value, LCBAX, and Vanguard’s Large Cap ETF, VV) the difference in Total Fees & Sales Charges is striking! We’re working on the charts, but in the meantime, by clicking on the table below you will taken to FINRA’s website for a clearer picture of this information. Under the scenario described above the AIM fund would cost the investor a total of $2,282 vs. $194 for the ETF over an identical 10 year period.
All other things being equal, wouldn’t you rather have the $2,088 ($2,282-$194) working to help you achieve your goal, rather than paid to brokers and spent on sales and marketing? You may think these investment choices were cherry picked, but the truth is, this example is not so unusual. The bottom line is—mutual funds can be expensive. In the above example, the 10 year cost of ownership is nearly 23% of the initial investment vs. just under 2% for the ETF!
Play around with the tool using your own portfolio of funds or better yet, talk to us to help you find ways to save money on your investment choices. We’re happy to review your portfolio holdings at no cost and let you know exactly what you have been or are currently being charged for the investments you hold.
There are a number of online resources available to investors who’d like to learn more about exchange-traded funds; we’ve found ishares.com, Vanguard.com, sectorspdr.com and Morningstar.com particularly helpful. Visit Finra.org for more information about The Financial Industry Regulatory Authority (FINRA).
Dec 17th
Weekly Economic Insight: 14 Dec – 18 Dec
Author: Kenn Lamson
Comments: 0
RELEASE
PERIOD
ACTUAL
EXPECTED (consensus)
LAST
HIA COMMENT
(leading, coincident, or lagging indicator)
November
0.8%
0.6%
0.1%
Manufacturing, which accounts for about 12% of the US economy, increased the pace of its rebound in November. The manufacturing component of the IP index spiked 1.1%, following a revised flat reading in October.
November
71.3%
71.2%
70.7%
CapU moved upward for the fifth consecutive month but remains near record lows and 9.6% below its long term average.
November (YoY)
1.8%
1.8%
-0.2%
The figure jumped to show positive growth largely due to higher energy prices.
November (YoY)
1.7%
1.8%
1.7%
The indices for shelter (which comprises about 40% of the total index weight) has posted a slight decline year-over-year, but several other categories are now showing marginal gains.
November
574K
575K
529K
November
584K
570K
552K
November
0.9%
0.7%
0.3%
The apparent stabilization in the manufacturing sector, while its unclear that it’s created jobs, is a tick in the positive column for the US economy. The Industrial Production figures reversed directions in November from their October readings. The overall IP reading, which slowed in October to 0.0%, rose substantially. Likewise, the reading on mining output jumped after a negative reading last month, while utilities output showed a sharp decline after rising in October. While expansion was broad-based, November’s gain was largely due to an 2.1% increase in output of the nation’s mines.
Factory capacity utilization remains extremely low and is especially weak in the manufacturing sector, which had a utilization rate of only 68.4% in November. A look at the utilization for the different stages of production shows clearly where the weakness lies:
While a high degree of spare capacity means inflation is unlikely in the near-term, it also suggests that companies’ profit margins have not sustained the degree of pressure they have seen in prior recessions.
The renewal of the $8000 first-time homebuyer tax credit probably contributed to the rebound in single family housing starts and permits. Also, multifamily construction swung back to an increase after last month’s plummet.
The month-over-month change in CPI was once again largely driven by energy costs; according to the Bureau of Labor Statistics the 4.1% rise in the energy component of the index, the largest since August, accounted for most of the “headline” index increase. While the “core” CPI has crept up from its probable cycle low of 1.4% in August, full-blown inflation has yet to appear. The “core” rate remains at a historically moderate level and there are few signs of pricing power at the retail level.
The Leading Economic Indicators continued their positive trajectory for the eighth consecutive month. We’ll surely welcome any legitimate good economic news. However, the most heavily weighted component, money supply (specifically M2), has exploded as the government has flooded the economy with fiscal and monetary stimulus. Unfortunately, little of that liquidity is being transmitted into the real economy, as bank lending is contracting – total loans and leases at US commercial banks fell by 6.4%, from $7,238B to $6,777B, from last November to this. It is, of course, actual lending to businesses and consumers that fuels the economy, not simply the existence of the funds on bank balance sheets. Other LEI components, like the “interest rate spread”, are suspect in their usefulness because this recession, stemming from a banking crisis and fueled by massive consumer deleveraging that has required that short term interest rates be held abnormally low, is quite different than other post-WW2 downturn. Long story short, we think the LEI is giving a false signal of the strength of economic recovery.