Investing your money is a critical decision.
I say ‘critical’ because if you do not invest your money in an appropriate medium chances are that you may end up losing your money. So, the critical decision involves selecting a right medium of investment.
Herein, Mutual Fund comes as a smart choice.
Having said that, Are there any considerations, which you need to make before investing in mutual funds, or is it that can you invest in any of the Mutual Funds that you come across?
Well, the answer is that you have to consider certain aspects of Mutual Funds before investing in them. If you get favorable answers then go ahead and invest in that Mutual Fund or else look for some other viable Mutual Fund for investment.
In this context, you need to consider the performance history and recent trends in the Mutual Fund you propose to invest.
Other than these factors, you also have to consider what is known as the Mutual Fund Expense Ratio.
In fact, the Mutual Fund Expense Ratio should be one of the foremost things to answer before you go out to buy a mutual fund or continue to hold a Mutual Fund.
What is Mutual Fund Expense Ratio?
Well, you have to take into account the overall cost of owning a Mutual Fund which is known as Mutual Fund Expense Ratio. It constitutes the expenses incurred in running a Mutual Fund. In simple words, the Mutual Fund Expense Ratio is the total of transaction costs, investment advisory fee, custody costs, administrative costs, 12b-1 Marketing Fees, transfer agent fees and other expenses, as well.
Thus, you can club all these costs under the head of Expense Ratio. Typically a Mutual Fund Expense Ratio comes to about 1.5% of money in the fund and is charged every year irrespective of the fact whether the stocks go up or the stocks go down. The Mutual Funds end up paying itself 1.5% of money within the fund each year. Moreover, Expense Ratio is likely to become more expensive as time goes by. So the cost of Expense Ratio is and would be a crucial factor to consider before buying any (actively managed) mutual fund.
Here under we have illustrated the vital components which constitute Mutual Fund Expense Ratio.
Management Fee or Investment Advisory Fee: It is the money paid to the fund manager(s) or the Fund Management Company who manage your Mutual Fund. It is the annual fees and comprises about 0.5% to 1% of the value of the fund’s assets. Management Fee or Investment Advisory Fee is by far the largest component of Expense Ratio. So lower the management fee better for you as an investor as it the money that you pay as an expense and it also does not compound your wealth. Thus, the Expense Ratio reduces drastically if the Management Fee or Investment Advisory Fee is lower.
Transaction Costs: It accounts for the commission paid to the stock brokers. Mutual Funds that have high turnover generate higher transaction costs as compared to the Mutual Funds which do not buy or sell investments often. In addition to the transaction costs, Mutual Funds, which have high turnover, attract higher capital gains taxes and other related expenses.
Administrative Costs: These are the costs incurred by the Mutual Fund Company and relate to costs such as that of record keeping, maintenance of a customer service line, mailings, etc. So these are the necessary costs which go in the administration of the funds and may differ from one fund to the other. Usually the administrative costs accounts for 0.20% of fund assets and may even run as high as 0.40%. So lower the administrative costs lower is the Expense Ratio that you have to pay.
12b-1 Marketing Fees: This is the fees used for advertising, marketing and promotion of the Mutual Funds. 12b-1 Marketing Fees is taken as annual fees and generally ranges from 0.25% to 1% of the fund’s assets. So, in a nutshell, this is the fees that you pay to the Mutual Fund Company for running commercials and for promoting itself to the public. Thus, you should go for Mutual Funds, which charge less or no 12b-1 Marketing Fees.
Custody Costs: Though custody costs constitute a small percentage of Expense Ratio, still you cannot ignore these costs. Actually the Mutual Fund Companies held their investments with a custodian bank. These banks register the stocks, securities, bonds on behalf of the Mutual Fund Company. They also collect dividends, manage corporate events, and carry out cost accounting for the Fund. All these activities incur costs which are collectively known as Custody Costs. So you should prefer such Mutual Funds which have low or negligible Custody Costs.
Transfer Agent Fees: Transfer Agents handle the tasks of keeping the records for the shareholders of a Mutual Fund. They process redemption and carry out purchase requests when the shareholders buy or sell their investments in the fund. They manage paper work, account statements, and other related work. All of this work incurs a cost known as Travel Agent Fees.
All-in-all, you should not ignore the costs related to Mutual Fund Expense Ratio. It is the money you pay to the Mutual Fund Company and moreover does not get invested. Finding good fund with low expense ratio can help you earn more on your mutual fund investment. So track the Expense Ratio of Mutual Funds to see which one has low expense ratio. You can check out websites or newspaper which show expense ratio of mutual funds. Now you can very well understand what is Mutual Fund Expense Ratio and can move on to select those Mutual Funds which have low Expense Ratio.