Investment Fees: Pros and Pitfalls


Many investments come with fees and unfortunately, some those of investment fees are not clearly advertised or discussed between broker and client. Some fees are obvious, and others are much harder to spot – but you may not even be looking for them. They’re somewhat hidden – you don’t realize how much you’re paying out until you suddenly notice your annual gains are much lower than expected because these fees diminished your returns.

One of the most common types of investment fees with annuities and mutual funds are Loads – also known as mutual fund sales charges or Shareholder Fees.  A “load” is a fee that is applied when trading funds and is calculated as a percentage of the investment amount to the advisory firm either when the investment is made (front-end load) or when the investment is sold (back-end load).

Back-end loads are generally accepted as a legitimate fee option in fully regulated markets like the US and the UK – as long as they are declared, clearly stated in the prospectus, and incorporated into the decision-making process.

There are other kinds of Loads, but the end result is that the loads take money out of your return either before, during, or after your investment in the fund.

How a back-end load works

For example, in a scenario where an investor pays a flat 5% back-end load: If they made an initial investment of $2,000 the full amount would go into the purchase of fund shares. After two years, the fund has achieved a 10% gain. The value of the shares is now $2,200 ($2,000 x .10 = $200). However, the investor decides to sell his shares. At this point, he is charged a flat 5% fee or $100. So the investor pockets only a $100 gain ($2,200 – $100 = $2,100). This does not include any other fees that may have been deducted from his fund such as 12b-1 fees and other service charges needed to cover the fund’s operating expenses. (Source: MarketBeat)

Back-end loads are also sometimes attached to a Contingent Deferred Sales Load (CDSL) – a common type of closing fee.  The total fee for this fund is calculated by how long the investor holds the position.  On average, the typical CDSL is 5%, if the investor holds the position for 1 year or less, 4% if the investor holds for 2 years or less, and all the way to 0% by the end of year 5.

Funds with CDSL’s almost always have an annual fee called a 12b-1 fee attached to the fund.  And this is where unsavvy investors lose a big chunk of their returns. According to Nasdaq, the 12b-1 fee is considered a “special marketing fee” – but the street calls it a disguised broker’s commission.

Things to be aware of with back-end loads

The back-end load is basically a commission charged by the brokerage or mutual fund houses on the selling of mutual funds by the investors as a percent of the total investment. The intended purpose of back-end loads is to discourage investors from regularly trading/selling their investments.

These don’t charge  upfront investment fees (front-end load) but charge a fee when shares in the fund are sold. The fee will be higher if you decide to sell in the first year, but it will decrease as you own the fund and will go away after about five to six years.

Therefore, it’s difficult to know exactly how much you will have to pay.  Experts say they can also be used by firms to earn additional fees at the end of the transaction, on top of the fees paid while the funds were under management.

“Investors should beware of unscrupulous financial advisors who deliberately hide the fee structure in small print just to make an investment option seem significantly cheaper to close the sale,” said Chris Lean, investment director, Aisa International.  “It’s always prudent to do due diligence with your advisor because there are strict regulations when it comes to transparency and the disclosure of these investment fees.”

Some pros of Back-end loads are that they:

  • discourage overtrading and unnecessary early withdrawals.
  • provide the necessary commission to fund managers and fund houses for managing the mutual funds.
  • have reduced or no fees if you hold the fund for five to ten years.
  • ensure all of your dollars go to work for you, unlike Class A shares where the sales load is deducted before dollars are invested. (After 6 to 8 years, class B shares may get converted to class A shares.)

Some cons of Back-end loads are that they:

  • reduce the profit earned by investors while selling their mutual funds.
  • add to fees without necessarily increasing returns.
  • discourage people from investing in mutual funds owing to reduced yield.
  • punish investors who must make early withdrawals to deal with emergencies.

Generally, analysts say back-end loads are an unnecessary expense for most investors in the 21st century as there are other widely available products that do not have these types of closing costs.

“Other investment options like no-load mutual funds, low-cost ETFs, and individual stocks typically do not charge sales loads and could help you reach your investment goals without the added costs,” added Lean.

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The views expressed in this article are not to be construed as personal advice. You should contact a qualified and ideally regulated adviser in order to obtain up-to-date personal advice with regard to your own personal circumstances. If you do not then you are acting under your own authority and deemed “execution only”. The author does not accept any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Where this article is dated then it is based on legislation as of the date. Legislation changes but articles are rarely updated, although sometimes a new article is written; so, please check for later articles or changes in legislation on official government websites, as this article should not be relied on in isolation.


“About
jett.vercruse@aisainternational.cz'

Jett Vercruse

Jett Vercruse is an American freelance writer with a B.A. in Journalism, Cum Laude, and is currently completing a Master's Degree in Law at Charles University in Prague.


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