Comparing mutual fund fees will be easier, but may be misleading
Investors in mutual funds are finally about to get some help in figuring out how much it costs them to make those investments. After talking about it for more than three years, the Securities and Exchange Commission has told mutual funds that starting May 1, all loads, fees, and charges must be displayed in a standardized table in the front of every prospectus. But like many new rules, this one has some potential drawbacks as well as benefits.
On the plus side, investors will now be able to make fully informed decisions based on a fund's front-end load, back-end load (redemption fee), annual management fees, and marketing charges. The table will show how a $1,000 investment would be affected by a fund's expenses over 1-year, 3-year, 5-year, and 10-year periods, assuming a 5 percent rate of return.
All of these fees and charges have always been included in prospectuses, but it sometimes took a CPA, a securities lawyer, or both to find and understand them. Now, it will be easy to find and compare the fees.
The negative side is that it may lead to too much emphasis placed on fees. Headlines like ``Lowest Fees of Any Growth Fund'' are likely to appear in financial advertising. But what some of these funds give you in low fees they may take away in poor performance.
``People shouldn't give too much emphasis to fees and expenses and not pay attention to a fund's performance, investment objectives, and risk,'' says Sarah O'Neil, associate general counsel at the Investment Company Institute, the mutual fund trade group.
``I'm less concerned about a 25-basis-point [one-quarter of a percent] difference in expenses if I'm buying good performance over the long term,'' agrees Neil Owen, a financial planner in Rye, N.Y.
While too much emphasis can be put on the fee tables, ``they should be helpful to people who are picking their own funds,'' Mr. Owen says. ``If you're looking at five different funds and one or two have expense ratios that are a lot different from the others, the tables will serve as a useful screen. Those funds will have to do some good work if they're going to justify those fees.''
Until the late 1970s and early '80s, keeping track of fees was easy. There were only two kinds of funds: load and no-load. Load funds paid a share of the customer's initial investment - usually 8 percent - to the broker, financial adviser, or planner who sold the fund. So if you handed over $1,000, you actually had only $915 working for you from the first day.
With some of these load funds, fees are scaled down for big investors. Someone putting in only a few thousand dollars will pay the full 8 percent, while the fee on an investment of $500,000 to $1 million might be only 1 or 2 percent.
With no-load funds, there are no salesmen. Shares are bought directly from the fund, so there is no front-end load or sales commission. That doesn't mean there are no fees; no-load funds - as well as load funds - take out a small percentage of assets each year for management fees, advertising, and other expenses.
At the Founders Funds in Denver, for example, there are five funds. The management fees range from 0.87 percent for the Blue Chip Fund to 1.66 percent for the Equity Income Fund, according to Elaine Kostikos, director of marketing at Founders.
In the last few years, the lines between load and no-load funds have blurred. Now, there are ``low load'' funds that charge 2 to 4 percent at the beginning, as well as funds with a variety of early-redemption charges.
Then there are 12b-1 fees for marketing and distribution expenses. At many funds, the presence and size of 12b-1 charges, named for an SEC rule permitting them, are buried deep in the prospectus. The new rules will require these to be clearly displayed.
In the spring, the National Association of Securities Dealers is expected to clarify the 12b-1 picture further by requiring newspaper listings of funds to carry a footnote to show whether they impose these fees. Since the footnote won't show how big the fee is, many funds are expected to drop 12b-1 charges altogether.
More help is coming from another SEC rule that takes effect at the same time as the rule on fee tables. This one will require funds to follow standardized - and stricter - rules for advertising. Currently, income funds are free to figure their yields any way they want to, which means some funds advertise a 30-day yield, 90-day yield, five-year yield, or anything else that makes them look good.
After May 1, however, income funds must advertise a standard 30-day yield figure. And if they want to advertise performance, they will have to show the fund's average annual total return for 1, 5, and 10 years.
While all this new information is needed and will be useful, investors will still have to weigh each fund's overall performance, risk, volatility, and their own investment goals. Just picking a fund with the lowest fees won't be enough.