Home Portfolio Management The Hidden Costs of Mutual Funds

The Hidden Costs of Mutual Funds

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Mutual fund investors are paying behind the scenes more than they might think. American funds charge 1.53% of assets per year and broker commissions add on around 1% in the U.S., according to a 2009 study Mutual Fund Fees Around the World.

Although this report is a few years old, Bloomberg wrote a nice article Hidden Fund Fees Mean U.K. Investors Pay Double US Rates this week.

Investors in England pay even more. British stock funds charge 2.48% of assets annually. Trading costs, performance fees and entry and exit charges tack on another 1.5%. What’s that, like 4%? Broker commissions, paid to financial consultants who get their clients to invest in the fund, is another expense. This figure is around 1% in America but uncapped in the U.K..

So Many Add-Ons

What wasn’t covered in either article is the total cost of funds. Sure, fund expenses pay the mutual fund company and its employees. Broker commissions tack on say another 1%. Well, what about trading costs? Say a fund manager calls a Goldman Sachs analyst about a stock, the analyst gives his recommendation to buy or sell, then the manager has Goldman run the trade and take a slice (in pennies per share) so the analyst (and brokerage firm) gets paid.

Say I was a fund manager and I put in an order to buy 10,000 shares of a $25.00 stock through a broker (funds use a retail broker because the analyst does the research). When the stock comes into my fund the cost is $25.02 to $25.05 depending on how much the analyst and I agree we should mark-up the shares. If I think the recomendation was unique, I’ll pay the guy a little more. This cost isn’t seen — I bought at say $25.05 total. The mutual fund investor sees nothing.

You see these trading desks on CNBC. Somebody’s paying for this. Funds are paying behind the scenes more than people think, and the cost gets buried inside.

Mutual Fund Costs are Unknown

With individually managed accounts, you see every penny on your statement. Advisory fees get charged quarterly and commissions are seen in each trade. With mutual funds you don’t really know how much is spent. Expense ratios, broker commissions, trading costs. Even with in-depth research from Citigroup, the London Business School, Harvard Business School and reporting from Bloomberg the total costs are still unknown.

David Sharek David Sharek is stock portfolio manager and CEO of DavidSharek.com. David believes a company's profits ultimately drive the price of its stock. His book The School of Hard Stocks can be found on Amazon.com.