|Course 107: Fund Costs|
While the fees we've discussed so far are levied by only certain types of funds, all funds annually charge—and deduct from your return—the following fees.
1. Expense Ratio. Most fund costs are bundled into the expense ratio, which is listed in a fund's prospectus and annual report as a percentage of assets. For example, if ABC Fund has assets of $200 million and charges $2 million in expenses, it will report an expense ratio of 1%.
The expense ratio has several parts. The largest element is usually the management fee, which goes to the fund family overseeing the portfolio. There are also administrative fees, which pay for things such as mailing out all those prospectuses, annual reports, and account statements. These fees are periodically deducted from the fund's overall assets. These deductions reduce the fund's portfolio value.
The 12b-1 fee can be another large component of the expense ratio; Such fees are levied by roughly half of all funds. These fees are named after an SEC rule that allows fund companies to use portfolio assets to cover a fund's distribution and advertising costs. These expenses can be as high as 1% of assets. Fees that fund families pay to no-transaction-fee networks, which we'll learn about in a later lesson, often get charged to fund shareholders via 12b-1 fees.
2. Brokerage Costs. These costs are incurred by a fund as it buys and sells securities, in much the same way you might pay brokerage fees if you were trading stocks online. These costs are not included in the expense ratio, but instead are listed separately in a fund's annual report or statement of additional information.
This figure excludes some hard-to-pin-down expenses. For example, when a fund invests in over-the-counter stocks (typically stocks traded on the Nasdaq exchange), it doesn't pay the broker a set fee. Rather, the cost of the transaction is built into the stock price. It is a trading expense that comes out of your return but fund companies don't report it separately.
3. Interest Expense. If a fund borrows money to buy securities—not a very common practice among mutual funds—it incurs interest costs. This is particularly common in mutual funds that engage in long/short strategies. Such expenses are also taken out of the shareholders' annual return.
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