Money Market Funds – Mutual Fund Loads and Sales Charges

Mutual fund fees have two basic categories of costs.  Shareholder fees that would include the costs funds charge when shares are purchased or redeemed.  In addition, all funds will have operating expenses, which represent the costs of running the fund.  A mutual fund’s fees and expenses are required by law to be clearly disclosed to investors in a fee table in the mutual fund’s prospectus. 

Operating a mutual fund involves costs and expenses.  Mutual funds bear expenses similar to other companies.  There are costs incurred in connection with particular investor transactions, such as investor purchases, exchanges, and redemptions.  There are also regular fund operating costs that are not necessarily associated with any particular investor transaction, such as investment advisory fees, marketing and distribution expenses, brokerage fees, and custodial, transfer agency, legal, and accountant’s fees.

Some funds cover the costs associated with an individual investor’s transactions and account by imposing fees and charges directly on the investor at the time of the transactions or periodically with respect to account fees.  These fees and charges are identified in a fee table, located near the front of a fund’s prospectus, under the heading shareholder Fees.

Fees and expenses vary from fund to fund.  A fund with high costs must perform better than a low-cost fund to generate the same returns for you.  Even small differences in fees can translate into large differences in returns over time.  For example, if you invested $10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $49,725.  But if the fund had expenses of only 0.5%, then you would end up with $60,858.  It takes only minutes to use a mutual fund cost calculator to compute how the costs of different mutual funds add up over time and eat into your returns.

Sales charges can be charged at different times when mutual fund shares are purchased or sold.  The category of sales charge, load, on purchases in the fee table of a mutual fund prospectus includes sales loads that investors pay when they purchase fund shares which are also known as front-end sales loads.  Sales fees or loads can be assessed at the time a consumer buys a fund or sells a fund.  If the sales charge is assessed at the time of purchase, the fee is referred to as front end load.  A sales load is like a commission investors pay when they purchase any type of security from a broker.  Although sales loads most frequently are used to compensate outside brokers that distribute fund shares, some funds that do not use outside brokers still charge sales loads. 

A key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares.  When the fee is subtracted up front, the purchaser is actually buying fewer shares in the mutual fund.  For instance, if a mutual fund has a 3% front end load, the prospective purchaser of $5,000.00 worth of shares will actually procure only $4,850.00 worth of shares.  The difference of $150.00 is the amount of the sales charge. 

Another form of sales charge is a back end load.  Back end loads are charges assessed at the time of sale of the mutual fund shares.  Back end loads are calculated based on the NAV of the shares.  When an investor purchases shares that are subject to a back-end sales load rather than a front-end sales load, no sales load is deducted at purchase, and all of the investors’ money is immediately used to purchase fund shares, assuming that no other fees or charges apply at the time of purchase.  For example, if an investor invests $10,000 in a fund with a 5% back-end sales load, and if there are no other purchase fees, the entire $10,000 will be used to purchase fund shares, and the 5% sales load is not deducted until the investor redeems his or her shares, at which point the fee is deducted from the redemption proceeds.

The last category of sales charges is a contingent deferred sales charge.  Under the terms of contingent deferred sales charges, the back end load diminish by some pre established set amount over time.  The longer one waits to sell the mutual fund shares the lower the sales charge.  In most cases, contingent deferred sales charges will be reduced to zero if the shares are held long enough.  The rate at which this fee will decline will be disclosed in the fund’s prospectus.

Similar to the back end load and the contingent deferred sales charge is the early redemption fee.  To discourage you from selling your shares of a fund too soon, most funds impose a redemption fee.  A early redemption fee is assessed if a customer sells their mutual fund shares within a certain time frame determined in advance.  Although a redemption fee is deducted from redemption proceeds just like a deferred sales load, it is not considered to be a sales load.  The SEC has adopted a rule addressing the imposition of redemption fees by mutual funds in Rule 22c-2 of the Investment Company Act of 1940. The SEC limits redemption fees to 2%.

Some mutual funds offer shares with no loads or sales charges.  As the name implies, this means that the fund does not charge any type of sales load.  As described above, however, not every type of shareholder fee is a sales load, and a no-load fund may charge fees that are not sales loads.  For example, a no-load fund is permitted to charge purchase fees, redemption fees, exchange fees, and account fees, none of which is considered to be a sales load.  In addition, under FINRA rules, a fund is permitted to pay its annual operating expenses and still call itself no-load, unless the combined amount of the fund’s 12b-1 fees or separate shareholder service fees exceeds 0.25% of the fund’s average annual net assets.

Virtually all money market mutual funds are no-load mutual funds in which investors purchase and redeem shares without paying a sales charge.  Expenses of the funds are instead deducted daily from gross income before shareholder dividends are declared.  The difference between the yield earned on a money market funds assets and the yield earned by shareholders is the money market funds expense ratio defined as the ratio of total expenses on an annual basis to average assets.  Institutional funds typically have lower expense ratios than other funds because of their much higher average balances.

Sales fees and redemption charges are not the only costs associated with owning mutual fund shares.  Mutual funds operating expenses or fees are the other charges associated with owning mutual fund shares.  Operating fund fees cover the mutual funds costs for management fees, administrative fees and marketing fees. 

Since operating the fund and managing the investments in a money market fund has expenses, you’ll pay a fee called the expense ratio, which helps pay the cost of running the fund.  The advertised yield has already had the expense ratio deducted.  Fees reduce the yield so it’s always important to look for a fund with a low expense ratio.  Funds typically pay their regular and recurring, fund-wide operating expenses out of fund assets, rather than by imposing separate fees and charges on investors.  These expenses are identified in the fee table in the fund’s prospectus under the heading annual fund operating expenses.

The fee structure of a mutual fund can be divided into two or three main components: management fee, non management expenses, and 12b-1/non-12b-1 fees.  All expenses are expressed as a percentage of the average daily net assets of the fund.

This entry was posted on Tuesday, January 6th, 2009 at 2:59 pm and is filed under Mutual Funds. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.