The Cost of a Mutual Fund

Buying mutual funds can both be a simple process as well as an exercise in frustration. The number of choices alone are dizzying, but the cost of a mutual fund is a bit confusing at times. Recent advice would tend to suggest that you should examine much more than just the expenses when considering a mutual fund, and this still holds true more or less.

Common wisdom suggests that it is best to avoid mutual funds with high expenses. Why bother to fight for modest returns when the fund manager is racking up expenses. However, the performance on a fund is usually given with rate of return after expenses–that is, after all of the operating expenses have been accounted for. The cost of owning, not buying, a mutual fund is usually defined as its expense ratio. The cost of buying a mutual fund is defined by its sale load.

The expense ratio contains the fees involved in running the fund including costs like the management fee and the operating costs. The price of sending out mailings, and in some case advertising for the fund, all fall under the category of costs. The expense ratio of mutual funds vary quite bit surprisingly. Some of the more efficient index funds have relatively low, like around .20% expense ratio, while the more expensive mutual funds sit around 1.5-2%.

The big problem with expensive mutual funds is that they are always hindered by that expense. The rate of return might go up and down, fluctuating with the market or economy, but that big up front expense will remain constant. A nice yield is hard enough to produce without having to fight against the tough odds of high costs.

Ultimately, there is more to consider than the expense of a mutual fund–the historical performance of the fund as well as the risk profile being among those. Still, a relatively expensive fund shouldn’t be completely ruled out if all the other factors fall in its favor.