Sales Charges, Fees And Other Expenses

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There are various types of expenses associated with purchasing and owning shares of mutual funds. We begin with the shareholders direct costs and then review the expense ratio, which is the one expense common to all funds.

Shareholder Costs

Transaction fees. Some funds charge their shareholders a redemption fee when they sell or redeem shares. Redemption fees are typically paid directly to the mutual fund and are designed to cover the costs associated with the redemption itself. Some funds also impose an exchange fee when a shareholder transfers from one fund to another fund within the same "family of funds". Some funds charge an annual account fee, typically a fixed amount deducted from the shareholder's account. Shareholders are often charged for accounts below the specified minimum balance.

Operating Expenses

Expense Ratio

• Salaries for portfolio managers, analysts and service representatives.
• The cost of printing shareholder reports.
• Other administrative costs, including an allowance for some fund company profit.

Rather than being deducted from your individual account, these expenses are taken from the assets of the entire mutual fund each day and are reflected in the fund’s cost per share.

Expense ratios vary widely. Some types of funds are, by their nature, more costly to run than others. For example, the following relationships are generally true.

• Stock funds are more expensive than bond funds.
• International stock funds are more expensive than funds that focus on U.S. stocks.
• Actively managed funds are more expensive than index funds.
• Funds with smaller levels of invested assets are more expensive than those with larger sums.

Taxes And Mutual Funds

Unless you own your shares inside a tax-advantaged account, such as an Individual Retirement Account (IRA), Coverdell Education Savings Account or an employer-provided 401(k) plan, you may be subject to federal income tax on earnings you receive from a mutual fund. Dividend and capital gain distributions are taxable, as are any capital gains you realize when you redeem shares.

As you select mutual funds for your portfolio, realize some are less tax-efficient than others. Funds with a high turnover rate tend to generate more capital gain distributions than those that hold securities for longer periods of time. Likewise, high-yield bond funds generate a large amount of taxable income. You may benefit from consulting a financial planning professional or tax accountant when deciding which funds to purchase within tax-advantaged accounts and which to purchase in taxable accounts.

You should also be conscious of how your own decisions affect your taxes. Those who rapidly buy and sell mutual funds may generate many capital gains and losses, potentially raising their taxes and certainly complicating their tax returns.

Many mutual funds are designed to minimize the tax burden of their investors. For example, some invest in municipal bonds which are issued by state and local governments to finance schools, roads, hospitals or stadiums. Called “munis” for short, a key attraction of municipal bonds is their tax treatment. In general, interest from municipal bonds is exempt not only from federal income tax but also from state and local income tax in the states and cities where they are issued. This tax treatment is passed through to municipal bond fund investors.