Mutual Funds and Exchange Traded Funds can be a wonderful tool to build diversified portfolios. Put simply, a fund company pools money from multiple investors, and buys stocks, bonds, and other investments with that money and the investors share in the profits or losses from those investments. The Mutual Fund Company charges a fee to manage those assets. The dirty little secret about Mutual Funds is that each Mutual Fund will have multiple “Share Classes”.
Each Share Class charges different fees for the same Mutual Fund. The Mutual Fund Company will receive the same fee to manage each share class but much of the excess fees are paid to broker/dealers as back-end commissions. At a broker/dealer, your broker can choose which Share Class they purchase for you based upon how much money they want to make from you in commissions. Here’s an example:
American Century Investments Equity Growth Fund is a popular Stock Mutual Fund that has six (6) Mutual Fund Classes, we will compare three.
Class A Shares charge you a 5.75% fee to purchase the fund in the first place, paid to your broker as a commission. The fund has an Annual Fee of 0.92%, 0.25% of which gets paid to your broker as a commission. Over 5 years, a $10,000 investment in this share class would cost you $1,056 in fees.
Class C Shares don’t have the upfront fee to purchase the shares but have an Annual Fee of 1.67%, 1.00% of which gets paid to your broker as a commission. If you sell the fund within 1 year you owe a 1.00% fee to sell the fund. Over 5 years, a $10,000 investment in this share class would cost you $908 in fees.
Class I Shares are the lowest cost share class. There is not an upfront fee to purchase the fund. The Annual Fee is 0.47%, and there is no fee to sell it. Over 5 years, a $10,000 investment in this share class would cost you $264 in fees, but your broker would receive no back end commissions for selling it.
Broker Dealer’s make a tremendous amount of their revenue from back end mutual fund sales commissions. An RIA, like Anchor Investment Management, makes no back end sales commissions and should always put you in the lowest cost share class for a particular fund.
Here’s another example of unnecessary Mutual Fund fees:
Two S&P 500 Index Funds should hold the exact same stocks in the exact same amounts. However, two S&P 500 Index Funds can charge vastly different management fees. The RYDEX S&P 500 Index Fund charges a 2.43% annual management fee. The Vanguard S&P 500 Index Fund charges a 0.03% annual management fee…for the exact same basket of stocks. Over five years, a $10,000 investment in the RYDEX fund would cost you $1,296 in fees, the Vanguard Fund would cost you $18.
In both cases, holding the wrong share class or the wrong fund can cost you a tremendous amount of money. Over 20 years the difference can be 1/3 of your overall portfolio. Either of these two scenarios is allowed at a broker-dealer because they are held to a “suitability standard” – the investments are “suitable” for the client. RIA’s, like Anchor Investment Management, are held to a “fiduciary standard”, we are legally obligated to do what’s in our clients’ best interest. We don’t make back-end commissions from Mutual Fund Companies and we will always purchase the lowest cost mutual funds and ETF’s for your account.