I agree with Rob Carrick that better disclosure of mutual fund fees and rate of return is worth the extra cost to investors. I’ve already written in the past however, that while I think more mutual fund fee disclosure is good, I doubt it will make much of a difference.
Most investors don’t read anything other than the account balance on their statements. Even if an investor does read about trailer fees and rate of return, they would still need to know what the numbers mean and if they are paying an amount appropriate to the service they are getting.
I can’t get people to look at their investment statements, but I can explain mutual fund trailer fees and personal rate of return.
What are mutual fund trailer fees?
Trailer fees are ongoing fees which are taken out of each mutual fund you own and paid to the company your advisor works for. The advisor will receive a cut of the trailer fee.
Most equity funds charge 1% annually which is based on the daily balance of your fund. If you have $100,000 of mutual fund A and that balance never changes – you will pay $1,000.00 in trailer fees in one year. Of course, all mutual funds do change value on a regular basis, so the trailer fee calculation is done on each business day.
The important fact to know is that these fees are taken out of the mutual fund itself and is reflected in a slightly lower price for your funds. The fees are not currently shown on statements and you will never be asked to pay the fees directly.
It’s very easy for an investor not to realize that trailer fees exists. It’s kind of like getting a paycheque which only shows your net pay and doesn’t indicate the gross pay or any of the taxes taken out.
What is a mutual fund personal rate of return vs the rate of return for the fund?
A mutual fund return is the investment performance as calculated for a mutual fund. A personal rate of return is a combination of the mutual fund return and the activities of the investor.
For example a company might advertise that a fund has a “12% annualized five year return”. This means that if you bought this fund exactly five years ago and didn’t do any other transactions, your return would also be 12% annualized.
But what if you bought it four years ago? Is your personal return still 12% annualized? It’s possible, but not likely. If a good chunk of the positive five year return occurred in that first year, then your four year annualized return will be lower than 12%.
The other factor is your activities with the mutual fund. When you buy mutual funds, do you purchase a lump sum and then never make more purchases or take money from that fund? Because all transactions you do in a fund will affect your personal rate of return.
How to get investors clued in?
The most effective way to get investors to realize how much they are paying in commissions of any type is to get them to pay the fees directly. Currently the fees all come out of the mutual fund and the investor never “pays” any fees and in most cases, have no idea how much the fees are or that they even exist.
Banning imbedded fees would mean that the financial industry would have to charge these fees directly to the investor, as in the investor will have to write a separate cheque for the money. This won’t help the issue of an investor not knowing if they are getting a good deal, but they will definitely know how much they are paying.
Explaining the rate of return is difficult. One suggestion would be to put the benchmark return on the statement along with the fund return, but even that is tricky. If you own a mutual fund, the fees go to pay the administration and portfolio management of the fund as well as paying your advisor. Those fees will be taken out of the performance of the fund, so it’s apples vs oranges to compare an active mutual fund you have purchased through an advisor with a do-it-yourself ETF.
Are you getting value from the advisor? Are they helping with tax info, asset allocation? You are paying for these services through the fees which impact returns. It might be worthwhile, but that’s something you have to evaluate yourself.
What do you think? Will more disclosure of these fees make much of a difference?