What you pay to purchase or sell a mutual fund, as well as the ongoing fund operating expenses, can have a great impact on the rate of return on your investments. So, keeping fees to a minimum is in your best interest. Generally, there are four categories of expenses—direct sales commissions, management fees, marketing costs, and overhead expenses.
Mutual funds come in two types: load and no-load. Load funds carry an up-front sales charge of 4% to 8.5% of the amount invested for "Class A" shares and are bought from a stockbroker, commission-based financial planner, and others who earn their living on sales commissions. A mutual fund is considered low-load if it carries a smaller up-front sales charge of 1% to 3%. Some funds charge a back-end load, also known as a contingent deferred sales charge (CDSC). You don’t pay a sales fee to get into the fund, but you will incur a sales charge on the way out if you sell early. These funds, commonly called "Class B" shares, were created to combat the negative image of up-front loads. Typically, the charge declines 1% each year until it disappears after the fifth or sixth year. However, management and marketing fees are usually higher on this version of a load fund. Try to avoid this arrangement if you don’t know how long you will hold the fund.
No-load funds, on the other hand, require no upfront fees to purchase shares and usually have no marketing fees. Investors deal directly with the fund company, a mutual fund supermarket (e.g., Charles Schwab, Waterhouse), or a fee-only financial planner, rather than with a broker. Some load and no-load funds also impose redemption fees to discourage investors from moving in and out of certain funds too frequently.
Both no-load and load funds charge annual money management and administrative fees. These costs are a percentage of the assets in the portfolio. These costs, in addition to the marketing/advertising fees, called a 12b-1 fee, make up a fund’s expense ratio. The 12b-1 fee pays for advertising and distribution costs, as well as broker compensation. Deducted from shareholder assets, 12b-1 fees can range from 0.1 to 1.00%, and every shareholder pays a pro rated share. Typical expense ratios, which can include a 12b-1 fee, range from 0.5% to 2% of fund portfolio assets. Beware of funds with expense ratios greater than 1.4% for stock funds, 1% for bond funds, and 0.5% for money market funds as this indicates that you are paying above-average costs.
Generally, no-load funds have lower fees than load funds, resulting in lower expense ratios. However, there is an exception—"Class C" shares—another version sold by a broker that has no sales charge but has a higher 12b-1 and management fee than either Class A or B shares. All things being equal, low cost funds will net you higher returns than high cost funds. Costs matter!