How to Find The Hidden Cost of Mutual Funds

Mutual Fund CostsI wish mutual fund companies actual sent us a bill each time they charged us. They don’t, of course, and so like The Dark Side of Placing Your Finances on Autopilot, we can easily forget about just how much they cost us. On top of that, not all costs of owning a mutual fund are easy to determine or understand. So here is a quick breakdown (if you want to jump to the hidden cost of mutual funds, see the last bullet point):

  • Loads: Loads come in two varieties–front-end and back-end. A front-end load is paid when you buy the fund. A back-end load is paid when you sell the fund. Loads generally go to the broker-dealer that is selling you the fund. Given all of the great no-load funds available, buying a load fund is almost always a waste of money.

The next group of fees are paid out of the fund, thereby reducing the fund’s returns:

  • How to Find the Hidden Cost of Mutual FundsManagement Fee: These fees are paid to the investment advisor who runs the fund. The fees are accrued daily and usually paid monthly or quarterly.
  • 12b-1 Fee: Named after the SEC rule that authorized funds to charge these fees, 12b-1 fees cover the costs of marketing the funds. The theory behind these funds (for those who care), was that by attracting more fund investors, over time, the fund could lower its costs as a percentage of money under management. Note that a fund cannot charge more than .25% in 12b-1 fees and still describe itself as a no-load fund.
  • Other Expenses: This is like the miscellaneous category in your budget, but generally pays the fund’s service providers.

In a fund’s prospectus, it must list its expense ratio, which is the amount of the above three expenses expressed as a percentage of the fund’s assets. For example, an expense ratio of 1% means that 1% of the money you invest in the fund each year will be paid to cover these costs. You can learn how to examine a fund’s expenses using from the How to Make the Most of Morningstar series. Oddly enough, there are additional costs that fall outside of the expense ratio! Here they are:

  • Redemption Fees: Redemption fees are charged when you sell or exchange a fund. Unlike back-end load fees, however, the fees go back into the fund to the benefit of the remaining investors in the fund. The purpose of redemption fees is to discourage short-term trading of the fund and to offset the related costs.
  • Brokerage Fees: Now we get to the hidden cost of mutual funds. The funds transaction costs from buying and selling securities are NOT included in the expense ratio. What! Yes, it’s true.

Here is a quote from Vanguard’s prospectus from one of its funds:

As is the case with all mutual funds, transaction costs incurred by the Fund for buying and selling securities are not reflected in the table, although such costs are reflected in the investment performance figures included in this prospectus.

So how do you determine those costs? Well, you have to go to a document funds are required to prepare called the Statement of Additional Information. In this document, the funds list the transaction costs from previous years. Particularly with smaller funds where these costs cannot be spread over a larger asset base, these expenses can be significant.

With that, the question is how much do you pay for your funds? My goal is to keep the weighted average cost of all funds under .25%. Currently, I’m at .22%. You can see how I do it in this post and podcast on how and why to keep investing costs low.

If you are not sure what your total fees are, check out Personal Capital. It’s a free online tool that will evaluate your portfolio, including fees. It even has a 401k fee analyzer.

401k Fee Analyzer

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Published or Updated: July 8, 2015
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.


  1. Fred Fnord says:

    Interesting stuff. Unfortunately, one thing you don’t mention in this article is how to find the damned information in the statement of additional information. The one for my T Rowe Price funds is 260-plus pages of ‘additional information’ regarding 40 or 50 different retirement funds, none of which is even remotely comprehensible.

    The numbers look pretty good otherwise: for example, one stock fund says in its summary that its Gross Expense Ratio is 0.3% (maximum sale charge is 0, 12b-1 Fee is 0), but I can’t make enough sense of the statement you mention to see what they’re doing with trading fees.

  2. Harriet Veenker says:

    What about how turnover of investments affects fees?

    • Rob Berger says:

      Harriet, an excellent point. Even in a mutual fund, turnover can absolutely affect fees. First, it increases the trading costs that the mutual fund passes on to its investors (trading fees are not included in the expense ratio). And for funds held in a taxable account, turnover can increase your tax liability.

  3. Mike says:

    You talk about brokerage fees as a hidden cost and the expense incurred when your broker buys and sells securities. This of course is hidden but is not something you really can compare with other funds and you are suggesting that smaller funds will cost more because these costs cannot be spread over a larger asset base and therefore is can be significant. However, this turnover will never be consistent from year to year or something you can avoid, unless you purchase a index fund that does less churning. You would want your fund to get rid of bad performing stocks and replace them with good performing stocks, which should far out way the expense of the transaction costs. Plus a smaller managed fund more actively managed could out perform a fund with so many securities it can not beat the market. It seems like a gamble. It appears you are advising to look for a mutual fund that has a high no. of securities in it. Can you give some examples of the minimum no. of securities to look for? Regardless, it seems like the expense ratio is the only thing you have to compare apples to apples when buying a fund. Also, what about ETF investing instead of mutual funds, would this provide a greater savings over time?

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