What expenses are involved in mutual fund investing?

When assessing the costs associated with a mutual fund, you should consider three types of expenses: sales charges, operating expenses, and taxes.

Sales Fees

Funds that charge sales fees are called load funds. Front-end load funds charge a fee when you purchase shares of the fund. Back-end load funds charge a commission when you sell your shares. Funds that do not charge a commission when you buy or sell shares are called no-load funds.

Operating Expenses

All funds have expenses associated with their ongoing management. Operating expenses cover investment advisory fees, legal and accounting services, and administrative costs. Additionally, some funds charge a distribution, or 12b-1, fee, which is used to cover various marketing costs. These expenses are often expressed as a percentage of a fund's net assets, and are called Expense Ratios, or Operating Expense Ratios.

Expenses can vary widely between mutual funds and can significantly affect the long-term growth of your investment. A fund's total return is always presented after deducting operating expenses. If two funds have identical investment results, but one fund has a 1% expense ratio and the other fund has a 1.5% expense ratio, the first fund would have a higher total return. A fund's expense ratio may be found in its Prospectus.

Taxes

Investors must also pay taxes on any realized gains associated with owning a fund. Investors earn money from funds in three different ways: dividend distributions, capital gains distributions, and capital gains from the sale of shares.

Dividends are the profits a corporation pays to its shareholders. When companies held by the fund pay dividends to the fund, the fund passes those dividends on to its shareholders, who must pay income tax on it. Dividend distributions are taxed at the same rate as ordinary income.

Capital gains are realized when a fund sells a stock for more than its purchase price. These gains are also passed through to fund shareholders, who must pay short-term or long-term capital gains taxes. Capital gains realized on securities held less than one year are considered short-term and are taxed as ordinary income. Long-term capital gains are incurred for securities held for more than a year and are taxed at a maximum rate of 20%.

Shareholders may also realize a capital gain when they sell individual shares of the fund for more than their purchase price. These gains are taxed at the short-term or long-term capital gains tax rate, depending on how long an investor has held shares in the fund.

Funds report these taxable expenses to shareholders at the end of each calendar year.