Today’s column for the Keys Weekly.

Island Investing
Cale Smith
June 27, 2009

Q. Can you explain mutual fund fees?

A. Let’s start with the basics. One in every two households in the Keys owns mutual funds, but many folks may not understand how they operate.

A mutual fund is a giant pool of money contributed by thousands of people. It’s usually invested in stocks or bonds, as chosen by a professional portfolio manager. There is a huge variety of mutual funds, from stock and bond funds to industry-specific funds to funds that invest in a single country. There are actually more than 8,000 domestic stock funds, which means there are more mutual funds in the country than Taco Bells.

Most fund fees fall into two categories: loads and expense ratios. A load is a one-time sales charge, assessed either when you first invest – a front-end load – or when you withdraw your money, called a back-end load. A typical load is about 3%.

Loads are commissions your broker and his firm earn for selling a fund. Paying a load is rarely if ever in your interest, so no-load funds are usually a much wiser choice.

The expense ratio is the cost of owning a mutual fund. It consists of management fees and a thinly disguised recurring commission known as a 12b-1 fee. The average expense ratio for a domestic, actively managed stock mutual fund is approximately 1.4%. That number, however, neglects the impact of trades made by the mutual fund, which eats up on average an additional 0.3% in costs.

Why worry about fees? They make a huge difference over the long-term. If you invest $10,000 in a fund that charges a 2% fee and grows at 12% a year, after 30 years you’ll have $174,000. Had you invested in a fund with a 1% fee, however, that same investment would be worth $229,000. That’s a $55,000 difference.

How can you minimize those fees? By using index funds, which we’ll cover next week.

In the meantime, for a copy of a free report “Ten Things You Need to Know Before Investing in Mutual Funds,” please send an email to [email protected].

Cale Smith is the portfolio manager for the Tarpon Folio and Gecko Folio. His firm’s website is www.islainvest.com and his blog is www.caleinthekeys.com.