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Mutual fund fees 'are a huge tax on the investor' — here's how to limit their impact

Beware of fee charges by brokers and mutual fund companies. Some are easier to spot than others.

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When it comes to mutual funds, you don't always get what you pay for. Depending on the fund you buy, you may get hit with a variety of different fees when you pick up or sell shares. Some of these charges are well advertised, while others will require some digging to unearth.

Assessing how much you're paying in fees is an important exercise. A few percentage points can make a big difference over the long term, says Will Rhind, founder and CEO of ETF firm GraniteShares. "People have figured out that investing or management fees are a huge tax on the investor," he says. "If you compound those fees over time, the effect on performance can be very significant."

If you're considering adding a mutual fund to, say, your brokerage account or individual retirement account, doing your homework lets you dodge a fee you didn't expect to pay, as well as avoid charges that can drastically erode the return on your investments over time.

Read on for three types of mutual fund fees you may encounter and strategies to avoid paying them.

Expense ratios: A loss leader for investors

Virtually all mutual funds and exchange-traded funds charge a fee to investors to cover the costs of managing the fund. Expressed as a percentage, a fund's expense ratio indicates what percentage of your total investment in the fund you pay to the fund company on an annual basis.

Passively managed funds, such as those that merely seek to replicate the return of a particular market index, are inexpensive to manage and therefore typically come with minimal expenses. Managers of actively managed funds are quite a bit better compensated, as they are trading more frequently and calibrating their portfolios to outperform their benchmarks over time.

As a result, these funds come with higher expenses. According to Morningstar's latest fee study, the average expense ratio for passive funds is 0.13%. Expenses at active funds average out to 0.66%, but can range much higher, with some funds clocking in with expense ratios north of 2%.

For this reason, Warren Buffett recommends passive index funds for the vast majority of investors.

What may seem like a small difference adds up over time. Say you invested $10,000 in a mutual fund that earns 8% per year for 40 years. If your investment had a 0.13% expense ratio, you'd end up with $206,000 and have shelled out $3,505 in fees over the years. Up the expenses to 0.66% and you're left with $166,000, and out more than $15,000 in fees.

To see how expenses and other fees affect your returns over time, use a fee calculator, such as this one offered by Bankrate.

Avoid sales charges by knowing your share classes

If you've ever sifted through a list of mutual funds, you may have noticed that the same fund will often come up several times. That's because mutual funds are divided into different share classes, which are offered to different kinds of investors. Each share class of the same fund holds the same identical portfolio, but comes with a different fee structure, and as a result, different returns.

As a rule, the more money you can put into a fund, the less you'll pay in fees. The share class marketed to institutional investors, such as university endowments or large corporations (and typically, your workplace retirement plan), often comes with investment minimums north of $100,000 and lower expense ratios that those marketed to individual investors.

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"If you have a billion dollars as an endowment, you're not paying a lot of these fees," says Bob Tull, co-founder and president of ETF firm ProcureAM. "If you go in as Johnny Retail with 2,500 bucks, you're paying."

Those share classes will also likely not come with a "load," which is mutual fund jargon for a sales charge. Loads generally come in two flavors: front-end and deferred.

A front-end load is paid when you buy shares. If you invest $1,000 in a fund with a front-end load of 5.75% (the highest rate that funds commonly charge), the amount you actually invest is $942.50, with $57.50 going to the mutual fund company.

Paying such a fee isn't the end of the world in the grand scheme of your investing life, but it should factor into your decision to buy, says Bob Bacarella, founder and chairman of mutual fund firm Monetta Funds. "If I told you that tomorrow the market was going to decline 5%, are you willing to buy that fund today?" he says. "That's what a load is. And if you say no, then you should not buy a load fund."

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A deferred load follows the same concept, but charges you when you sell your shares. In this case, you'll use your entire $1,000 to buy shares in the fund, but you'll pay a percentage of your investment (typically the lower of the value at the time of purchase and the value when you sell) when you redeem your shares for cash.

These loads typically disappear if you hold the fund for a certain amount of time — in many cases, several years. Another form of this fee, known as a redemption fee, will charge you a percentage of assets when you sell, but only to discourage active trading. The fee typically expires after 30 to 90 days.

For a quick and dirty way to figure out if you'll pay a load on your fund, take a look at the fund's share class, which is typically listed at the end of a fund's name. Mutual fund companies can follow their own naming conventions, but you'll often find that "A-class" shares carry a front-end load while "C-class" shares come with a deferred load. Pimco Total Return A (PTTAX) charges a 3.75% front-end load, for instance, while Pimco Total Return C (PTTCX) comes with a 1.00% deferred load.

Funds with "Investor" or "Retail" at the end of the name typically come with no load. To check for a load on any fund, type the ticker symbol into Morningstar.com and navigate to the fund's "Price" page.

Transaction fees depend on your brokerage

Even you're not forking much money over to the mutual fund company in the form of expenses or sales charges, you may go to buy a fund and find that you owe a fee to your brokerage for the privilege. If you go to purchase, say, a $3,000 stake in Vanguard Equity-Income Fund Investor Shares (VEIPX) — a fund that doesn't come with a load — you'll end up paying $3,075 for your shares, with $75 going to Fidelity.

That's because the fund isn't on Fidelity's list of no-transaction-fee (NTF) funds — an assembly of funds offered by the brokerage or ones offered by firms that partner with the brokerage.

Most major online brokers, such as Charles Schwab, E*Trade, Fidelity, and TD Ameritrade offer somewhere in the neighborhood of 4,000 NTF funds, which can be purchased with no load and no transaction fee. You're likeliest to run into fees when you purchase funds issued by a competing brokerage — hence the charge for buying a Vanguard fund through Fidelity.

If you're focused on buying from a particular family of mutual funds, it may make sense to sign up with a brokerage who offers those funds in its NTF program. If you already have a brokerage account, shop from its roster of NTF funds to build a portfolio sans extraneous fees.

Overall, an investor focus on fees has forced both brokerages and mutual fund companies to tamp down on fees in recent years. Still, being vigilant about what you're paying for your investments now can prevent them from eating into your long-term returns.

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