If you’re employing the service of others — for example, when someone manages your money (comingled with others’ money) in a mutual fund — then you should be familiar with the idiom, “Nothing in life is free.” Mutual funds, even index mutual funds, have a management fee or “expense ratio.” You may have to find the fund’s prospectus or use an online tool like Yahoo Finance to determine how high the associated fee is.
For mutual funds, it’s not always true that the higher the fee, the better the service. Fortune Magazine suggests looking for less expensive funds.
Be wary of any mutual fund charging a management fee higher than 1 percent (a few stellar managers may be worth it; most are not). A manager with a high buying and selling rate (called “turnover”) should also set off warning bells. If you aren’t interested in watching your fund manager like a hawk, stick with an index fund, like one from Vanguard, where expenses are typically around 0.2 percent. And if you’re trading stocks, don’t be fooled by low commissions: They add up.
If you’ve ever looked at a prospectus — and if you invest in mutual funds, presumably you have — you will notice that the section on fees is detailed and possibly intimidating. The more confusing this section is, the more people will ignore it. To decipher the myriad fees listed in a prospectus, keep this website handy.
In addition to Fortune Magazine’s 1% maximum fee guidance, I’d also suggest that you look for fees with no front-end load. One of my biggest mistakes was periodically investing a fixed amount in AIVSX. While the fund performs well sometimes, 5% of each investment was taken off the top to give to someone I never met. Now my money just sits and grows in that fund, and all of my current investing outside of my 401(k) takes place in low-expense mutual funds.
Published or updated December 20, 2006.