The Impact of Mutual Fund Fees

How fees erode your return over time.

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Mutual fund annual fees—which include management fees, administrative costs, and marketing expenses—can really make a dent in your overall return. You may be surprised by how much. Say two people invest $10,000 in two different stock funds, which both gain an average of 8 percent per year over 10 years. Fund A charges 0.5 percent in annual fees, and Fund B charges 1.5 percent. A decade later, Fund A will deliver a return of roughly $20,530 while Fund B will return $18,560. To compare fund returns yourself, taking into account expenses, the Securities and Exchange Commission offers a mutual fund calculator on its website.

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Morningstar analyst Jonathan Rahbar says that "keeping a blind eye to fees" is one of the biggest mistakes mutual fund investors make. It's important to be aware of how much you're paying in annual fees for each of your funds. Here are a few tips for keeping fees low.

Make a plan. Determine what types of funds are right for you. Start with the lowest-cost, core funds available, Rahbar says. ("Core" funds are those that typically make up a large portion of investors' portfolios, such as U.S. large-cap funds.) Looking for managers who have a consistently solid long-term record in both bull and bear markets and employ a low turnover strategy (meaning they hold stocks for long periods and therefore invest with a longer-term horizon). Rahbar recommends that investors limit more aggressive funds with loftier fees to a smaller portion of their portfolio.

[See Should You Deep-Six Your Mutual Fund?]

Think broadly. Large-cap funds are generally the cheapest to own. The median annual fee for no-load, large-cap funds is 0.95 percent, while the median for no-load small-cap funds is 1.20 percent, according to Morningstar. Because smaller companies require more research, they tend to be more expensive. The same goes for specialized funds, such as those that invest in a particular sector. In general, look for funds with expenses that are lower than the median in their category. For broad exposure to large-cap funds, Rahbar suggests investing in any of the S&P 500 index funds. Investors should also consider funds that hold small- and mid-cap stocks and international stocks.

Watch out for loads. Sales charges—also called "loads"—are often levied when you purchase or sell a fund through a broker or financial adviser. There are two types of sales loads: Front-end loads are upfront charges, and back-end loads are applied when investors sell the funds. Keep in mind that advisers also use no-load funds or have access to load-waived funds. Some experts, like Adam Bold, founder of the Mutual Fund Store, believe investors should stay away from any type of sales loads. "Remember that when you pay a load, the load does not go to the mutual fund company; the load goes to the broker who is selling you that fund," he says. To put front loads into perspective, consider the above example but this time with an upfront fee. If a particular fund has 5 percent front load and you invest $10,000 in the fund, you're handing over $500 upfront. Back-end loads are assessed by how long the investor holds the fund. Depending on how well the fund performs, the fees can be taken from your initial investment or from the total return if the fund declined over the period you held it. Back-end loads can also be used as incentives for investors to hold a fund longer because brokers generally charge a lower fee in this case. It's important to read a fund's prospectus because funds often have different fee structures.