In my last post, I showed how index funds allow you to save more money by losing less of your investment returns to management fees.
Here is what different management expense ratio (MER) levels will cost you on an initial $10,000 investment at 10% growth compounded annually:
|0.20% MER||5 years||10 years||25 years||40 years|
|What’s left for you||$15,959||$25,470||$103,528||$420,817|
|1.00% MER||5 years||10 years||25 years||40 years|
|What’s left for you||$15,386||$23,674||$86,231||$314,094|
|2.50% MER||5 years||10 years||25 years||40 years|
|What’s left for you||$14,356||$20,610||$60,983||$180,442|
Now, 40 years is a long span of time, and most of us are probably not even thinking about that far out. However, even if you don’t plan on working for the next 40 years, chances are that you aren’t planning on consuming your entire nest egg by then, either. Therefore, as your nest egg continues to compound and grow, so too will the total fees paid.
These fees are invisible in a sense, because the difference is that instead of you receiving the full sum and then having to pay the fee back to the company, this is money that you lose out on because you never see it in the first place.
However, to add insult to injury, many mutual funds sold by banks and advisors come with additional fees on top of what you already lose out on through MERs!
Here are the most common types of fees:
- Sales charge (front-end load)
- Deferred sales (back-end load)
- Low load
- Early redemption fee
The last fee mentioned here is special, since it is typically used to recoup expenses for the fund, instead of as compensation to a broker or advisor for selling you the fund.
Sales charge (front-end load)
This type of fee is paid when you purchase units in a mutual fund. If a fund has a 5.5% front-end load and you invested $10,000, then you would pay a sales charge of $550 to the broker or advisor. You would only have $9,450 invested! Your investment needs to return at least 5.8% just to break even.
Deferred sales (back-end load)
This type of fee is sneakier than the front-end load, since it is paid when you decide to sell your units and withdraw or transfer your money. In this case, if a fund has a 5.5% back-end load and you invested $10,000, then you would pay a sales charge of $550 upon withdrawal of the funds. This type of fee may decrease over time to $0; for example, if the time limit was 5 years, then you could withdraw your original $10,000 without charge after 5 years. Anything invested more recently would still be charged a fee upon withdrawal!
This is similar to the back-end load, except that the fees charged may be smaller, and the time over which fees are charged is typically shorter.
Early redemption fee
Unlike the other three types of sales fees, an early redemption fee is not charged to reward a broker or advisor for selling the funds. It is instead charged in order to recoup costs for the funds and also to help discourage short-term buying and selling. Some Vanguard funds, otherwise known for their very low MERs, charge a 1% early redemption fee.
Investing it wisely
Avoid all types of sales fees by going with low-cost index funds. Many of the best investors of all time are aware of how the industry operates, which is why they often invest in the companies selling these products rather than in the products themselves. Many advisors don’t even know much about index funds, since they are trained to sell you funds that are more profitable for the bank. Since they are trying to make more money for the bank and for themselves, this is what they will try to push on you. Show that you’re educated and informed by letting them know what you want, and always verify that there are absolutely no sales charges associated with what you’re buying.
Further reading and references
- Andrew Hallam: Book Review: The Elements of Investing
- US Securities and Exchange Commission: Mutual Fund Fees and Expenses
So, have you ever had a negative experience with sales charges? We unfortunately have a couple of investments from our college days that have back-end load charges attached to them. At least we only tied up a couple of K this way, but lesson well learned!