“Finance is the art of passing money from hand to hand until it finally disappears.” – Robert W. Sarnoff.
From the “it’s about time” category, I present the Supreme Court case Jones v. Harris Associates. The case was filed because a group of investors felt:
- The board of directors wasn’t sufficiently neutral (the law requires 40% of advisers to be “disinterested”).
- The fund didn’t disclose the advisers’ financial links to the trustees
- Compensation for the adviser should be controlled by a majority of the disinterested advisers
As Jason Zweig of the Wall Street Journal writes, the Supreme court has no business setting fees. However, the disclosure rules on mutual funds stem from older laws. Is it time for reform in fund disclosure?
Let Me See That
Neutrality is a major issue when it comes to these fund boards. Former fund partners can join the board independently in as little as 2 years from when they leave the fund. This is hardly ‘neutrality’. Additionally, fund price reductions (known as ‘breakpoints’) are seldom reviewed. Breakpoints often will reduce fees on a fund when a certain amount of assets under management is reached. I agree with Zweig when he says, “The court should spell out the kind of objective data that boards must review in order to evaluate whether fees are fair, including what other clients pay for equivalent services, what investors in an index fund would pay and how much more — or less — it costs the manager to run a big fund than a small one.” Indeed. If you want price competition in the mutual fund world, you’ve got to open the books.
Fees, Fees, and More Fees
The SEC lists five types of fees your mutual funds can pass on to you:
- Front and back end sales loads. This means when you buy or sell you can be hit by a fee of x%.
- Redemption fees. Similar to back end sales loads, you would pay these when you sell your fund.
- Exchange fees. Yes, some fund companies will charge you when you transfer between funds in the same group.
- Account fees. This is a maintainance fee, often charged to people below an asset threshold in a fund.
- Purchase fees. Similar to front end sales loads, you pay these when buying a fund.
Of course, there are other maintainance fees on your fund. In addition to the management fee, there is a fee cloaked in secrecy known as the 12b-1 fee. This secretive fee is used to pay expenses and materials for a fund. However, it is also used for marketing purposes. This fee is capped at .75% of assets yearly. Also, you’ve got ‘other’ expenses. There is a summary of these types of expenses in the Total Expenses disclosure.
Yes, for all of their asset allocation goodness (and don’t forget, by letting someone else manage your assets you are saving time!) mutual funds have a number of hard to understand fees. Transparency into how these fees are set (and neutral fund boards) would go a long way to ensuring funds serve their investors better.
Remember, compounding is just as dramatic when it works against you. For your consideration (let’s ignore tax… and don’t hate on my choice of fund type or returns):
Flash Player 9 or higher is required to view the chart Click here to download Flash Player nowYou invest $10,000 in a fund which aims to match the S&P 500. The S&P 500 is well behaved for 20 years, returning 10% annually (Nice.). If you had invested directly in the S&P 500 stocks, you would have $67,275.00. Not bad! The fund’s value, however, will only be $51,120.46. What if you had a fund with fees of only .09% like the ETF SPY? Well, you’d have $66,182.65. SPY presents a cost of 1.99% of the potential value, whereas your fund presents a cost of 24.29%. Choose wisely.
Ridiculous example aside, fund fees paid by investors have come down over the years (investors have flocked to lower fee funds… note the 2008 average fund fee is 1.44%). Follow the trend… invest in low-fee funds. Hopefully the Supreme Court will ensure even more transparency in the future with their guidance on this case. If everyone moves towards the cheaper funds, other funds will be forced to drop their fees in return… that’s how the market works. Happy investing!
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