April 4, 2011
Whether you follow Wall Street or not, odds are you’re a mutual fund investor. Mutual funds are the foundation of 401(k) plans and individual retirement accounts.
Michael Finke, associate professor of personal financial planning at Texas Tech University, and a widely published fund investing researcher.
Myth: All mutual fund fees are bad.
Many funds assess sales charges up front, along with the ongoing expenses that cover operations. Yet there is another one-time charge that might actually make long-term investors money: redemption fees. About one-quarter of funds charge investors who pull out of a fund shortly after getting in, typically within six months or less. The charges are capped at 2 percent of the amount invested.
These fees became common after a scandal in 2003 when some funds were caught favoring certain big investors who frequently moved in and out of the fund. Such rapid trading can saddle all of a fund’s investors with higher costs, eroding returns. Many companies tried to regain favor with long-term investors by initiating redemption fees.
Research coauthored by Finke showed that many mutual funds that charged redemption fees had significantly higher average returns than comparable funds that didn’t charge — as much as 3 percent in some instances.
Advantages were most apparent for funds investing in small-cap stocks. However, many fund companies are now abandoning redemption fees because they present a marketing problem. Investors tend to avoid anything resembling an extra fee, even if few pay them.
“But if you’re a long-term investor,’’ Finke says, “you want a fund to impose fees on short-term investors that are taking money out of your pocket.’’