In this week's Motley Fool Answers, Alison Southwick and Robert Brokamp reveal some lesser-known facts about these pooled investment vehicles. Here's one that may might even tick you off a bit: The expense ratio -- the percentage of your money that they say are going to take from you each year to run the fund -- leaves out a whole host of commissions, marketing fees, and taxes that will take a bite out of your profits.
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A full transcript follows the video.
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This podcast was recorded on Oct. 4, 2016.
Alison Southwick:All right. The second thing that you maybe didn't know, but probably should, about mutual funds is that the expense ratio isn't the final word on what you're paying. It's just not that clear-cut, is it?
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Robert Brokamp:Right. And when we talk about costs with a mutual fund, that's the first place you look, is the expense ratio, and it's always expressed as a percentage. It's the percentage of assets that the fund company is going to take of your money to cover all the costs -- the management, the administrative costs, recordkeeping, and things like that.
Southwick:Like if I give a mutual fund a hundred bucks, and its fee is 1%...
Southwick:... then every year? Every quarter? I know you've told me this before.
Brokamp:Every day there's an end-of-the-day accounting for the costs and the value of all the investments in the fund, and then they do that accordingly.
Southwick:And then they just pull a few pennies away.
Brokamp:Exactly. So that's the first place people look, but it actually doesn't account for all the costs. It doesn't account, for example, for the commissions that the fund manager pays to buy and sell the investments. It doesn't account for any commissions you paid to get into the fund -- so a front-end load or a back-end load. That's generally if you're buying it from a financial advisor, but not always. Some funds do charge a front-end load ...
Southwick:And a front-end load is like an initial one-time 5% fee or something.
Brokamp:Exactly, 5%. Even Vanguard used to charge front-end loads on some of their funds -- or on the back end -- because they were trying to discourage people from being in there for the short term. They were trying to get people to pay if they were just holding it for the short term.
And then there are the taxes, which we talked about in the "Answers, Answers" segment. There are even some well-known money managers, fund managers, asset managers who in their taxable accounts know that they should just stick with index funds because the taxes that come from investing in actively managed funds can outweigh any benefits in many cases.
Southwick:Are 12B-1 fees still around?
Brokamp:Yes, and that is an ongoing marketing fee. When you think about it, you as a current fund shareholder are paying for the marketing costs to acquire...
Brokamp:... new shareholders.
Southwick:That's so crazy.
Brokamp:It's kind of ridiculous. Not all of that is expressed purely in the expense ratio. To find out, for example, the commissions the manager is paying to buy and sell the stocks, bonds, or whatever is in the fund, you actually have to dig into their financial statement, so it's very difficult to find.
The closest thing to which you can approximate it is something they call theturnover rate, and that is each fund has a turnover expressed as a percentage. It's basically how much of the fund's investments have been bought and sold in the course of a year. Theoretically, if a fund had a turnover of 100%, that means everything it had at the beginning of the year was gone at the end of the year. That will give you an idea of how much trading there is and how much in taxes might be generated.
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