For the average person, investing can be a complicated, intimidating endeavor. Between stocks, bonds, mutual funds, brokers and other equally confusing terms, it can be difficult to not only get a decent grasp of what it all means but, even more importantly, find investments that are most suitable for the investor.
Even once that’s accomplished, figuring out if your investments are too expensive is the next crucial step. After all, every penny that goes into the pockets of brokers and management companies is a penny not going into your account.
Fortunately, when it comes to the most popular type of investment for the typical investor, mutual funds, there are a few readily available data points that can be very insightful in highlighting costs and, ultimately, helping you find out if you’re paying too much for your investments.
What Exactly Are Mutual Funds?
When you invest in a mutual fund, no matter the type of account, your money is managed by a fund manager who combines it with money from other investors of the fund. All of that money is then invested into individual positions depending on the guidelines spelled out in the fund prospectus. Depending on the nature and goals of the fund, the pooled money can be channeled into numerous different stocks, bonds, commodities, real estate or nearly any other type of investment available.
In other words, mutual funds truly shine by providing investors the ability to easily achieve a large amount of diversity in their portfolio by simply investing into a single fund. With multiple funds, investors can achieve even more diversity. Also, by choosing mutual funds that adhere to their investment goals and risk tolerance, ranging from conservative to aggressive, investors can allow their money to work for them in the most suitable manner.
The Dark Side of Mutual Funds: Costs
Of course, no investment is perfect. Aside from suitability and performance standards, no other factor is as important as costs and fees. And while all mutual funds have these costs and fees in some capacity, the range of possible expenses is quite large. Although there are a few different sources of cost in mutual funds, the two of most concern are annual expenses and sales charges, also referred to as sales loads.
Annual expenses represent the total cost levied by the management company on an annual basis. These costs are built into the fund value, so they tend to be very subtle. However, as subtle as they are, they come directly out of fund performance and thus directly out of an investor’s account balance, so minimizing them is in an investor’s best interest.
By researching funds through any number of reputable online services, investors can gauge the relative expense of a fund against similar ones. If a fund is significantly more expensive than competing funds without the performance history to justify them, chances are that fund is too expensive.
Another possible source of expenses is in sales charges or loads. These are incurred when a fund investment is placed through a financial advisor and can be levied up front as a front-end load or spread out through a number of years. The majority of these charges are essentially a commission that goes to the advisor and, unfortunately, are levied along with annual expenses. Of course, no one wants to pay more fees than necessary, so using loaded funds with sales charges are typically only appropriate when an investor derives enough benefit from working with a financial advisor to justify the extra expense.
Like most aspects of investing, there are no steadfast rules when it comes to costs. Investors should do their research to make sure their funds are reasonably priced relative to similar funds. Also, if the expertise and guidance of a financial advisor justifies the additional cost of a sales charge, then paying commissions might be worth those extra costs.