A study published in the Journal of Financial Research indicated that the fees charged by the average stock fund were unchanged during the 1990s (Mutual Funds, July 2002, page 55). That may have been good news back then, but now that stock market returns have dropped, fund expenses as a percentage of your return might actually be higher. Therefore, this may be a good time to figure out what you are paying for and how you're paying for it.
For example, say that you have a municipal bond fund that hypothetically pays you a 5% dividend. Let's also say that the fund hypothetically collects 1% in fees. Out of a total of 6%, the fund takes 1% or 16% of the total income. You may be surprised that you pay this high a percentage in costs.
A fund's expenses are broken into three categories:
- Management fees include investment advisory fees and administrative or other fees paid to the investment adviser or its affiliates.
- Rule 12b-1 fees include all distribution or other expenses incurred to market the fund to new investors.
- Other expenses are those not included in the first two categories that are deducted from fund assets or charged to all shareholder accounts. These include payments to transfer agents, securities custodians, attorneys, auditors, fund independent directors, and providers of shareholder accounting services.
A fund's expense ratio is its total expenses divided by average net assets and is published in its prospectus. It is, however, difficult to compare the fees and expenses paid by funds because the manner in which they pay these expenses can vary widely. Sometimes the cost of all services provided to the fund and its shareholders is included in a fund's expense ratio. Other times this ratio excludes some services, such as marketing or financial advice, because they are paid by the individual shareholder.