Costs of Investing

A fourth issue is the costs and fees of mutual funds. Regardless of the gross returns earned by a fund, investors ultimately get to keep only the net return. If an investor pays a load charge of five percent, that amount comes off the top of the investment, leaving only 95 percent of the investor's funds actually invested in shares.

Operating expenses are deducted before cash flows are paid to shareholders. Obviously, the higher the operating fees, the lower the net returns. As we saw earlier, many mutual funds have different classes of shares, the so-called Class A, B, and C shares, with different expense ratios. If you buy the Class B or Class C shares, you pay substantially more with the expense ratio than you would with the Class A shares. Over time, this makes a substantial difference in your cumulative net returns.

Many funds now have very high turnover ratios. Years ago the turnover rates were on the order of 20 or 30 percent of the portfolio. In today's world, turnover rates are often 100 percent of the portfolio or even more. This means that a fund is doing significant trading in the quest for superior performance. Obviously, even ignoring the issue of whether they make enough good decisions with this trading to make it worthwhile, costs are being generated. The higher the fund's operating costs, the lower the net return to investors. Meanwhile the funds are generating tax liabilities for shareholders.

The bottom line is that the costs of buying and owning mutual funds have been rising . More funds are switching from being no-load funds to imposing a sales charge to fund investors. For example, the Scudder family was one of the pioneers in the no-load format, and some of its funds, such as Scudder Income, now impose a significant sales charge. The same is true of the Invesco family of funds, long a no-load family. On average, the sales charge has risen for all funds in recent years, now averaging more than five percent.