Mutual fund fees can erode returns PERSONAL FINANCE

STAYING AHEAD

February 21, 1993|By JANE BRYANT QUINN | JANE BRYANT QUINN,1993, Washington Post Writers Group

New York --If you buy mutual funds from a stockbroker or financial planner, you're being sliced up to pay sales fees. It's entirely proper to pay a salesperson for advice. But you may not realize how large your fees can grow over the years, or the damage that does to your investment returns -- especially in bond funds, where average returns aren't all that high in the first place.

The National Association of Securities Dealers (NASD) will impose a new rule beginning July 7 to suppress the unregulated growth of mutual-fund sales charges. But it's not going to save you a lot of money.

The cheapest funds to own are the "no-loads" (those with no sales charges), which you buy directly from a fund organization. On average, no-loads do better than "load" funds, because less of your money is raked off for expenses.

If you'd rather buy through a broker or planner, however, here are the various ways you might pay:

* Pay now. The sales load is subtracted, upfront, from the money you invest. Loads typically run from around 4 percent to 6.5 percent today, although they can go as high as 8.5 percent. Many investors loathe upfront loads and avoid them when they can. But if you plan to hold for many years, this is usually the cheapest way of buying a load fund.

* Pay later. There's no charge going in, but you pay if you sell within a specified time. It might cost you 6 percent to leave after one year, 5 percent after two years, and so on. Not until six years have passed can you sell at no charge.

* Pay forever. All "pay-later" funds and many "pay-now" funds add a second fee known as a 12b-1 (named after a Securities and Exchange Commission rule). These 12b-1s have been running from 0.5 percent to 1.25 percent of the funds' assets, subtracted every year. This is the nastiest charge of all. If you hold for many years, a 12b-1 fee will cost you more than a front-end load.

A growing number of load funds let you decide how to cover the fee. When you make your purchase, your options are a front-end load plus a small 12b-1 fee or no front-end load plus a large 12b-1 fee, usually with an exit charge for selling too soon. Which choice is best depends on how long you'll hold.

As an example, take two funds earning 11 percent before expenses -- one with a 4 percent upfront load and a 1 percent 12b-1, the other with no upfront load and a 3 percent 12b-1. After five years, the performance of the front-loaded fund will be running 5 percent ahead, says Bob Edwards of Investability Corp., which tracks fund performance.

The new NASD rule limits 12b-1 fees to 0.75 percent a year plus a 0.25 percent service fee, starting in July. Many of the pricier funds have already cut their costs to this level. Unfortunately, some of the lower-cost funds may eventually have to charge more. They fear that stockbrokers and planners will demand service fees as their price of recommending a fund.

The NASD rule limits the total the fund can collect in sales charges to a specified percentage of new sales it makes. One likely result, according to the NASD's Elliott Curzon: Mutual funds that perform poorly for several years, and don't attract enough new investors, won't be able to charge the full 12b-1. This will lower the cost to investors who choose to stay with the fund.

Under the rule, by the way, a fund with no upfront sales charge, and whose 12b-1 isn't over 0.25 percent, can still call itself "no-load." This infuriates the true no-load funds that charge no 12b-1s at all.

* Pay double forever. Many financial planners and stockbrokers now manage your money by investing it in mutual funds. For this, they charge a "wrap fee" of 1 percent to 2 percent of your assets annually. If the funds also charge a 1 percent 12b-1 and service fee, you're paying 2 percent to 3 percent. That's a losing proposition. Stock investors are better off buying Vanguard's Index Trust, which tracks the broad stock-market average, and forgetting everything else.

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