Kennedy Advisory Group
3109 Woodcliff Cr.
Birmingham, Alabama 35243
As information sources have increased, along with it has come more chances to look behind the curtain. For example, the mutual fund industry in America is enormous; most Americans currently use these products for accumulating funds for retirement and many other uses.
Mutual funds collect assets ranging from stocks, bonds, real estate (REITs), and other asset classes. Fees and expenses must be charged or assessed to make the funds operate. When a mutual fund has purchased its prospectus (disclosure), its goals are included in the sales process. In the prospectus is full disclosure of fees and expenses; however, many who buy mutual funds rarely understand all of them.
Most mutual fund owners easily understand the cost of acquiring the fund (loads) and running the fund (expense ratio). However, what is rarely understood is how the fund buys and sells the assets in the fund. These are known as the “invisible” fees.
The amount of buying and selling during a year is calculated and disclosed in a term known as the “turnover” ratio. This term refers to the percentage of sold or purchased assets during the year. The number of turnover ratios can vary significantly with the type of mutual fund. Funds that are actively managed would tend to have a higher turnover ratio as the fund managers attempt to increase the yield on the overall fund. The opposite would also probably be true: funds passively managed to have a lower turnover ratio.
Why is this important? It is important for two reasons when an asset is sold; a potentially taxable event may occur. The second reason is this: every time an asset is bought or sold, a sales expense is incurred. This expense is before the expense ratio calculation and is in addition to the expense ratio.
While it is difficult to know what this expense is, common sense would dictate that a lower turnover ratio would translate to lower acquisition and selling expenses. This expense is known as the “invisible” expense, few know about it, and almost no one knows what the actual expense of it is in any specific mutual fund.
It is not disclosed: why? It is not revealed because the SEC does not require it to be disclosed. An article in US News and World Report said this about the undisclosed hidden fee:
Transaction costs. A 2007 study by Edelen, Evans, and Kadlec found that U.S. stock mutual funds have an average transaction cost of 1.44 percent per year, not included in the expense ratio. These fees are not found in most prospectuses and can be challenging to determine. http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2015/03/04/the-mutual-fund-fees-we-dont-talk-about
Barron’s, in a 2013 article, further quoted Professor Roger Edelen (professor of finance, UC Davis) about fees for asset acquisition: http://www.barrons.com/articles/SB50001424052748704356104578326293404837234.
If you invest in mutual funds (as 53.2 million Americans do, 43% of all American households), ask the right questions before making any final decision.
Most brokers may not know about acquisition fees, but you show yourself as a knowledgeable investor by asking.
Read the prospectus and ask questions.
Many mutual fund prospectuses can be hundreds of pages long, ask for the prospectus summary, and ask questions from there.
Disclaimer: the author of this article is NOT security licensed and not authorized to sell securities or give investment advice. The author is a fixed annuity
salesman and licensed via state of residence.
Safe Money insights and tips sent to your inbox twice a month.Sign Up Now!