Published December 10, 2012
Last year the oldest members of the Baby Boom generation turned 65 years old and millions of them are investing in mutual funds that are stealing their income.
It matters because many Baby Boomers have shifted their investment goals from growth to income and as a result, they're relying on the cash flow generated from their investments to sustain their lifestyle. How much of their income are mutual funds devouring?
Fund Expenses 101
First things first: There is no such thing as a "free" mutual fund or "free" investment. In my previous days working as a financial advisor, I had a prospective client tell me his mutual fund portfolio wasn't costing him anything. I showed him the fees in his fund prospectus. He was surprised.
Broadly speaking, mutual funds fall into one of two categories; "no load" or "load."
No load funds, as the name implies do not incur a sales charge, but if you purchase the fund through a fund marketplace, brokerage firms will typically charge you a transaction fee to buy or sell the fund.
In contrast, load funds charge upfront or backend commissions, which are paid to a fund salesperson.
Once you've purchased a mutual fund, the ongoing fees you pay are called the "expense ratio." This ratio or cost is the percentage of a portfolio's average net assets used to pay its expenses. Among the costs included in a fund's expense ratio are management fees, administrative fees, and 12b-1 marketing fees. Even though these fees aren't necessarily billed via a monthly invoice, they are a significant ongoing cost that directly reduces investor returns and income.
How Much am I Losing?
The conventional step for comparing mutual fund expenses is to use peer group comparisons by analyzing funds in the same category.
For instance, the fund expenses of a large cap (NYSEArca:SCHB) or emerging markets fund (NYSEArca:VWO) is compared to its peers in that same category. And if the annual fees or expense ratio for a particular fund is more than its peers, then it's overcharging and if it's less than it's not. While peer group comparisons are OK for analyzing mutual fund expenses, they only tell part of the story.
Along with traditional measures, ETFguide uses an alternative benchmark for mutual fund costs that gets straight to the bottom line. We look at the percentage of income that fund expenses are consuming from shareholders based upon the fund's 12-month yield. By this standard, many mutual funds badly fail.
In FIGURE 1, we evaluated the expense ratios and yields of popular income mutual funds to find out how much income was being consumed by the fund's annual expenses. We looked at the Fidelity New Markets Income (Nasdaq:FNMIX), Fidelity High Income (Nasdaq:SPHIX), Franklin Utilities (Nasdaq:FRAUX), Loomis Sayles (Nasdaq:LSBRX), and T.Rowe Price Equity Income (Nasdaq:PRFDX).
We discovered that fund expenses among with these popular income mutual funds were sucking away a startling 12% to 35% of investor's income. Unlike taxes, this particular tax - a mutual fund income tax - can be avoided. How?
The Secret to Getting More Income
Step 1 is to start looking at your fund investments in terms of how much of your income they are eating up and Step 2 is to eliminate them. Step 3 is to user lower cost alternatives, for example, index ETFs.
Step 4 is to understand that traditional income sources like dividend stocks (NYSEArca:DVY) and long-term bonds (NYSEArca:TLT) are under assault. The combination of low interest rates and higher looming taxes on dividend income means that income investors are not generating the kind of income they once did.
The ETF Income Mix Portfolio we've assembled has been helping our readers to combat today's anti-income/anti-investor climate. Since early 2012, our monthly income trades have averaged $1,040 per month* in cash flow in addition to traditional income sources coming from dividends. (*Based on a hypothetical $100,000 all ETF portfolio) The annual expense ratio for this portfolio is just 0.18%.
Neither the mutual fund industry nor the spendthrift government or the Federal Reserve are your friends. The confiscation of your money is their goal.
Fund companies are built for maximum profits for themselves. The government wants to increase taxes on your qualified dividends from 15% to 39.6%. And BernanQE & Co. is destroying income investors with low rates. Fighting back with a proven strategy is the only way to win.
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