As with any business, running a mutual fund involves costs. For example, 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 accountants’ 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 the fee table, located near the front of a fund’s prospectus, under the heading "Shareholder Fees."
Funds typically pay their regular and recurring, fund-wide operating expenses out of fund assets, rather than by imposing separate fees and charges directly on investors. (Keep in mind, however, that because these expenses are paid out of fund assets, investors are paying them indirectly.) These expenses are identified in the fee table in the fund’s prospectus under the heading "Annual Fund Operating Expenses."
In the fee table, under the heading of "Shareholder Fees," you will find:
Sales Loads (including Sales Charge (Load) on Purchases and Deferred Sales Charge (Load))
In the fee table, under the heading of "Annual Fund Operating Expenses," you will find:
Distribution [and/or Service] (12b-1) Fees
Total Annual Fund Operating Expenses
Funds that use brokers to sell their shares typically compensate the brokers. Funds may do this by imposing a fee on investors, known as a sales load (or sales charge), which is paid to the selling brokers. In this respect, 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. There are two general types of sales loads—a front-end sales load investors pay when they purchase fund shares and a back-end or deferred sales load investors pay when they redeem their shares.
Sales Charge (Load) on Purchases – Front-End Loads
The category "Sales Charge (Load) on Purchases" in the fee table includes sales loads that investors pay when they purchase fund shares (also known as front-end sales loads). The key point to keep in mind about a front-end sales load is it reduces the amount available to purchase fund shares. For example, if an investor writes a $10,000 check to a fund for the purchase of fund shares, and the fund has a 5% front-end sales load, the total amount of the sales load will be $500. The $500 sales load is first deducted from the $10,000 check (and typically paid to a selling broker), and assuming no other front-end fees, the remaining $9,500 is used to purchase fund shares for the investor.
Deferred Sales Charge (Load) – Back-End Loads
The category "Deferred Sales Charge (Load)" in the fee table refers to a sales load that investors pay when they redeem fund shares (that is, sell their shares back to the fund). You may also see this referred to as a deferred or back-end sales load. 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.
Typically, a fund calculates the amount of a back-end sales load based on the lesser of the value of the shareholder’s initial investment or the value of the shareholder’s investment at redemption. For example, if the shareholder initially invests $10,000, and at redemption the investment has appreciated to $12,000, a back-end sales load calculated in this manner would be based on the value of the initial investment—$10,000—not on the value of the investment at redemption. Investors should carefully read a fund’s prospectus to determine whether the fund calculates its back-end sales load in this manner.
The most common type of back-end sales load is the "contingent deferred sales load," also referred to as a "CDSC," or "CDSL." The amount of this type of load will depend on how long the investor holds his or her shares and typically decreases to zero if the investor holds his or her shares long enough. For example, a contingent deferred sales load might be 5% if an investor holds his or her shares for one year, 4% if the investor holds his or her shares for two years, and so on until the load goes away completely. The rate at which this fee will decline will be disclosed in the fund’s prospectus.
A Word about No-Load Funds
Some funds call themselves no-load. 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.
A redemption fee is another type of fee that some funds charge their shareholders when the shareholders redeem their shares. Although a redemption fee is deducted from redemption proceeds just like a deferred sales load, it is not considered to be a sales load. Unlike a sales load, which is used to pay brokers, a redemption fee is typically used to defray fund costs associated with a shareholder’s redemption and is paid directly to the fund, not to a broker. The SEC limits redemption fees to 2%.
An exchange fee is a fee that some funds impose on shareholders if they exchange (transfer) to another fund within the same fund group.
An account fee is a fee that some funds separately impose on investors in connection with the maintenance of their accounts. For example, some funds impose an account maintenance fee on accounts whose value is less than a certain dollar amount.
A purchase fee is another type of fee that some funds charge their shareholders when the shareholders purchase their shares. A purchase fee differs from, and is not considered to be, a front-end sales load because a purchase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund’s costs associated with the purchase.
Annual Fund Operating Expenses
Management fees are fees that are paid out of fund assets to the fund’s investment adviser (or its affiliates) for managing the fund’s investment portfolio and for administrative fees payable to the investment adviser that are not included in the "Other Expenses" category.
Distribution [and/or Service] (12b-1) Fees
This category identifies so-called "12b-1 fees," which are fees paid by the fund out of fund assets to cover distribution expenses and sometimes shareholder service expenses. 12b-1 fees get their name from the SEC rule that authorizes a fund to pay them. The rule permits a fund to pay distribution fees out of fund assets only if the fund has adopted a plan (12b-1 plan) authorizing their payment.
“Distribution fees" include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares, and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature.
Some 12b-1 plans also authorize and include "shareholder service fees," which are fees paid to persons to respond to investor inquiries and provide investors with information about their investments. A fund may pay shareholder service fees without adopting a 12b-1 plan. If shareholder service fees are part of a fund’s 12b-1 plan, these fees will be included in this category of the fee table. If shareholder service fees are paid outside a 12b-1 plan, then they will be included in the "Other Expenses" category.
Included in this category are expenses not included in the categories "Management Fees" or "Distribution [and/or Service] (12b-1) Fees." Examples include: shareholder service expenses that are not included in the "Distribution [and/or Service] (12b-1) Fees" category; custodial expenses; legal expenses; accounting expenses; transfer agent expenses; and other administrative expenses.
Total Annual Fund Operating Expenses
This line of the fee table is the total of a fund’s annual fund operating expenses, expressed as a percentage of the fund’s average net assets.
A Word about Mutual Fund Fees and Expenses
As you might expect, 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 5% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly $19,612. But if the fund had expenses of only 0.5%, then you would end up with $24,002 – a 23% difference. It takes only minutes to use a mutual fund cost calculator such as FINRA’s Fund Analyzer to compute how the costs of different mutual funds add up over time and eat into your returns.