The excessive costs of mutual funds significantly prevent the growth of your investment assets, especially over longer periods of time. Because mutual funds are professionally managed investments, there are significant management fees, operating expenses and 12b-1 (advertising) fees associated with investing in a fund. These fees and expenses charged by the fund are passed onto shareholders and deducted from the fund's return. They significantly prevent the growth of your investment assets, especially over longer periods of time.

SEC guidelines allow for charges up to 3% before being considered excessive. Wrap accounts, where a financial planner chooses an asset allocation using mutual funds or money managers, add on another 1.25% to 2.6% on top of the previously mentioned charges (the investor is essentially paying for two layers of management).

Make yourself aware of all the fees and expenses incurred in your mutual funds. You may be shocked. Go to the U.S. Securities and Exchange Commission website for more information. In addition, our Education Center contains The True Cost Of Fees, which specifically quantifies in dollars the excessive costs of your mutual funds.

Defining Mutual Fund Costs

Mutual fund costs fall into three main categories: one-time fees, ongoing annual expenses and other fees.

1. One-Time Fees ('Loads')

Loads come in three forms:

Front-End Load

• Charged when you purchase fund shares, effectively reducing your purchase amount
• May be charged on reinvested distributions
• Can be as high as 8.5%

Back-End Load

• Charged when you sell fund shares
• Usually assessed based on the length of time you have held your shares, and declines over time
• Maximum allowed is 8.5%, but this is rarely seen. According to Lipper Inc., back-end loads can be as high as 6% if you sell shares within one year

Level Load

• Deducted annually from fund assets as marketing and distribution costs
• Used to pay commissions to brokers and the fund's financial adviser, and is generally reported as part of a fund's operating expenses
• According to Lipper, Inc., can be as high as 0.75% per year

2. Ongoing Annual Expenses

These expenses include

• Management Fees
• Distribution and Service Fees
• Other Expenses
• Underlying Fund Expenses

3. Other Fees

Other fees may include

• Transaction fees for buying or selling fund shares
• Redemption fees if the fund is held for less than a certain period of time, generally between 90 and 180 days

The Bottom Line

The excessive costs of mutual funds significantly prevent the growth of your investment assets, especially over longer periods of time

The following short excerpt is from the article 'Mutual Funds Are A Loser's Game' (Wall Street Journal, July 8, 2003 ) written by John C. Bogle, founder and former CEO of The Vanguard Group.

Investors seem largely unaware of the substantial gap by which stock, bond and money market funds lag the returns of the markets in which they invest. While the Standard & Poor's 500 Stock Index has risen at a 12.2% average annual rate since 1984, for example, the average equity fund has grown at a 9.3% rate, only three-quarters of the stock market's return. Bond funds have earned only a slightly higher fraction of bond market returns. And yields of money-market funds are less than one-half of the current yields on short-term investments.

What accounts for these shortfalls? They are largely created by the costs incurred by mutual funds. How could it possibly be otherwise? With expert professional investors dominating the financial markets, as a group they must earn the market return before costs (a zero-sum game) and fall short of the market by the amount of the same costs they incur in the futile effort to gain an edge (a loser's game).

The costs of playing the game are surprisingly large. They include mutual-fund expense ratios, which reached an all-time high of 1.6% of equity-fund assets last year. Turnover costs, by conservative estimates, total another eight-tenths of 1%. Adding the impact of sales charges, out-of-pocket fees, and other expenses, 'all-in' costs for the average equity fund come to as much as 3% per year - not surprisingly, very close to the 2.9 percentage points by which the annual returns of mutual funds lagged the stock market during 1984-2002.

Originally rooted in a focus on stewardship, the fund industry has gradually come to focus instead on salesmanship. Once dominated by highly-diversified equity funds whose returns tended to parallel the U.S. stock market itself, today eight of every 10 equity funds limit their investments to specific benchmarks like large-cap growth stocks or small-cap value stocks - or on narrow industry groups such as technology and telecommunication.

This bewildering array of choices among nearly 5,000 equity funds has ill served investors. The returns incurred by the average equity fund investor since 1984 have averaged just 2.7% per year, a shocking shortfall to the 9.3% return earned by the average fund. The result is that the average fund investor has earned less than one-quarter of the stock market's 12.2% annual return. Compounding these annual returns over the 1984-2002 period presents a dramatic picture of the plight of the typical mutual fund investor:

$1,000 invested at the outset would have produced a profit of $7,910 in the stock market itself (the performance of the S&P 500 Index), a profit of $4,420 for the average equity fund, and a profit of just $660 for the average equity-fund investor.