The Costs of MF's

Costs are the biggest problem with mutual funds. These costs eat into your return, and they are the main reason why the majority of funds end up with sub-par performance. What's even more disturbing is the way the fund industry hides costs through a layer of financial complexity and jargon. Some critics of the industry say that mutual fund companies get away with the fees they charge only because the average investor does not understand what he/she is paying for. Fees can be broken down into two categories:
1. Ongoing yearly fees to keep you invested in the fund.
2. Transaction fees paid when you buy or sell shares in a fund (loads).
The Expense Ratio The ongoing expenses of a mutual fund is represented by the expense ratio. This is sometimes also referred to as the management expense ratio (MER). The expense ratio is composed of the following:
• The cost of hiring the fund manager(s) - Also known as the management fee, this cost is between 0.5% and 1% of assets on average. While it sounds small, this fee ensures that mutual fund managers remain in the country's top echelon of earners. Think about it for a second: 1% of 250 million (a small mutual fund) is $2.5 million - fund managers are definitely not going hungry! It's true that paying managers is a necessary fee, but don't think that a high fee assures superior performance.
• Administrative costs - These include necessities such as postage, record keeping, customer service, cappuccino machines, etc. Some funds are excellent at minimizing these costs while others (the ones with the cappuccino machines in the office) are not.
• The last part of the ongoing fee (in the United States anyway) is known as the 12B-1 fee. This expense goes toward paying brokerage commissions and toward advertising and promoting the fund. That's right, if you invest in a fund with a 12B-1 fee, you are paying for the fund to run commercials and sell itself! On the whole, expense ratios range from as low as 0.2% (usually for index funds) to as high as 2%. The average equity mutual fund charges around 1.3%-1.5%. You'll generally pay more for specialty or international funds, which require more expertise from managers. Are high fees worth it? You get what you pay for, right? Wrong. Just about every study ever done has shown no correlation between high expense ratios and high returns. This is a fact. If you want more evidence, consider this quote from the Securities and Exchange Commission's website: "Higher expense funds do not, on average, perform better than lower expense funds." Loads, A.K.A. "Fee for Salesperson" Loads are just fees that a fund uses to compensate brokers or other salespeople for selling you the mutual fund. All you really need to know about loads is this: don't buy funds with loads. In case you are still curious, here is how certain loads work:
• Front-end loads - These are the most simple type of load: you pay the fee when you purchase the fund. If you invest $1,000 in a mutual fund with a 5% front-end load, $50 will pay for the sales charge, and $950 will be invested in the fund. • Back-end loads (also known as deferred sales charges) - These are a bit more complicated. In such a fund you pay the a back-end load if you sell a fund within a certain time frame. A typical example is a 6% back-end load that decreases to 0% in the seventh year. The load is 6% if you sell in the first year, 5% in the second year, etc. If you don't sell the mutual fund until the seventh year, you don't have to pay the back-end load at all. A no-load fund sells its shares without a commission or sales charge. Some in the mutual fund industry will tell you that the load is the fee that pays for the service of a broker choosing the correct fund for you. According to this argument, your returns will be higher because the professional advice put you into a better fund. There is little to no evidence that shows a correlation between load funds and superior performance. In fact, when you take the fees into account, the average load fund performs worse than a no-load fund. (For related reading, see Start Investing With Only $1,000.)

MF ADS(Dont be fooled)

Perhaps you've noticed all those mutual fund ads that quote their amazingly high one-year rates of return. Your first thought is "wow, that mutual fund did great!" Well, yes it did great last year, but then you look at the three-year performance, which is lower, and the five year, which is yet even lower. What's the underlying story here? Let's look at a real example. These figures came from a local paper: 1 year 3 year 5 year 53% 20% 11% Last year, the fund had excellent performance at 53%. But in the past three years the average annual return was 20%. What did it do in years 1 and 2 to bring the average return down to 20%? Some simple math shows us that the fund made an average return of 3.5% over those first two years: 20% = (53% + 3.5% + 3.5%)/3. Because that is only an average, it is very possible that the fund lost money in one of those years. It gets worse when we look at the five-year performance. We know that in the last year the fund returned 53% and in years 2 and 3 we are guessing it returned around 3.5%. So what happened in years 4 and 5 to bring the average return down to 11%? Again, by doing some simple calculations we find that the fund must have lost money, an average of -2.5% each year of those two years: 11% = (53% + 3.5% + 3.5% - 2.5% - 2.5%)/5. Now the fund's performance doesn't look so good! It should be mentioned that, for the sake of simplicity, this example, besides making some big assumptions, doesn't include calculating compound interest. Still, the point wasn't to be technically accurate but to demonstrate how misleading mutual fund ads can be. A fund that loses money for a few years can bump the average up significantly with one or two strong years.