Although investors know about mutual funds, not all of them understand exactly how mutual funds work. However, this comes as no surprise, as not everyone is a financial expert, and may have other things going on in their lives other than learning the companies’ fund structure. On the other hand, investors may be able to choose more wisely by understanding such matters.
It is required by the Securities and Exchange Commission (SEC) that a fund company have to disclose their shareholder’s fees, as well as their operating expenses in their fund prospectus. In fact, it is clear that fund companies make their biggest part of revenue from the fees they charge.
Because of their combination of low cost and higher returns, mutual funds are one of the most popular and successful investment vehicles. Investing in mutual funds is nothing like putting money into a savings account or on a certificate of deposit in a bank. Purchasing mutual funds is letting you own shares in a company.
There are three different ways in which a shareholder can make their money. One of those ways is by means of dividends and interest that they receive in payments from the fund’s holdings. Another way is via the trades made through management; should a mutual fund have capital gain from a trade, this is passed on to their shareholders, known as ‘distribution of capital gain.’ The third way is through appreciation of standard assets, simply meaning that the value of the mutual fund shares got larger.
There can be any number of various products and services fees in a fund company.
Load fees (sales charge fees) are triggered when mutual fund shares are purchased. This goes to say that the investor will have to pay a percentage. This is usually around 5%, plus the cost of the share itself. A huge part of the sales charges is paid out to other brokers and the advisers that originally sold the fund.
The front-end load fees get deducted from an investment amount before the purchase is actually made. When shares have been sold, you have the back-end sales load that can also be charged.
Mutual fund companies cannot run their business and provide their services free of charge. They have expenses, and that money has to be replaced somehow. The fund company’s expenses cover the administrative staff, investment advisers, distribution fees, fund research analysts, and many others.
Management fees are taken out of the fund assets. It is a requirement of the SEC for management fees to be listed separate from other expenses. Investors eventually hear about the distribution fees, which are referred to as the 12b-1 fees. These fees do get charged off the shareholders in order to replace spending costs related to marketing and services provided.
There are a variety of mutual funds that do not charge fees. However, many funds may claim they have a no-load status, but will still get compensated through marketing and distribution expenses by means of 12b-1 fees, cheating the SEC somewhat.
Are you starting to trade with mutual funds? Don’t hesitate to ask questions in the comments and read our mutual funds guide for beginners or learn how to choose the best mutual fund for you.