Separately, a fund's annual expense ratio is deducted from fund assets and comprises fees associated with fund management as well as 12b-1 fees, if applicable. The expense ratio also includes operating expenses, such as legal, accounting and auditing fees.
Sales loads, based on a percentage of the purchase amount, vary from one type of fund to another, says Wade Slome, president and founder of Sidoxia Capital Management in Newport Beach, Calif.
A front-end sales load typically costs 5 percent, but another type of sales load is buried in the expense ratio. Known as 12b-1 fees, they are used to compensate brokers or to cover expenses for marketing the funds.
"Your general equity fund, while I wouldn't use this as a hard and fast rule, charges anywhere from 75 basis points to 125 basis points, or 0.75 percent to 1.25 percent," Slome says, referring to total expense ratios, including 12b-1 and management fees. "You could probably subtract 50 basis points, or 0.5 percent, from that range to kind of get the (sales load for the) fixed-income bond fund."
Not all funds charge fees on sales. Those that don't are called no-load funds. These can be purchased directly by individual investors from a fund company without a broker or adviser.
In cases where sales loads apply, Place suggests checking the prospectus for information on break points, or sales fee discounts for purchasing a minimum dollar amount in shares.
Returns an important gaugeWhile fees matter, Mecca says it's important to put them in context. "Sometimes people tend to make investment decisions (by picking) the lowest management fees," he says. "We think that's a recipe for disaster. We look at the greatest net return. Let's say Mutual Fund A has a management fee of 0.7 percent, and the returns are 10 percent. That means the net is 9.3 percent. Let's say Mutual Fund B has a management fee of 1.5 percent, but its returns have averaged 13 percent. Now you have a net return that's even higher than the other one."
Mutual fund returns are always expressed net of expenses, or after expenses are deducted.
Mecca's argument is well taken, though it's difficult to know in advance which funds with high expense ratios will wildly outperform their benchmarks or their peers. Advisers have to depend on past performance, and the caveat, "the fund's past performance does not necessarily predict future results," is included in fund literature -- an SEC requirement.
For that reason, many advisers choose for their clients no-load funds with low expenses as well as consistent, risk-adjusted returns.
Slome firmly believes that "the no-load is the best way" because it means lower fees. "By calling up the 800 number of a mutual fund company, the investor can avoid paying a middleman broker a load fee," he says. "The reason that some investors pay a load fee is because they are supposedly paying the broker for the advice of which fund to buy."
When choosing funds for clients, Mecca likes to look at returns over a 10-year period and compare the fund's performance to that of the relevant index over the same period.
"If it's underperformed more than three times, then I usually don't like the fund," Mecca says. "Seven out of the last 10 years, I'd like it to outperform the index."