Are Mutual Funds Really as Agreeable as They Seem or Are Hidden Fees Costing You More Than You Think?

Mutual funds are a popular choice for many investors, particularly those who are managing their own portfolios. If you’re looking for what to invest in, it’s likely you’ve come across a mutual fund (or several). On the surface, these seem like an obvious option: they have already done the work of diversification for you, they’re professionally managed, and they’re easily accessible on most investment platforms.  

What you may not know is that mutual funds can carry additional costs related to their share classes. These classes, commonly labeled A, B, or C, come with varying fee structures, including potential upfront charges, ongoing expenses, and investment minimums. It’s important to research and understand these details before investing in a mutual fund.

While mutual funds may appear attractive, it’s worth noting that their associated fees and expenses can affect overall investment performance over time. Being aware of these costs can help you make more informed decisions based on your financial goals and circumstances.

So, what exactly is a mutual fund?

Mutual funds are managed by fund managers who aim to accomplish the fund’s investment goals. These funds are typically comprised of a diversified portfolio of stocks, bonds, or other assets. The primary goals of this diversification are to reduce risk and increase potential profits.

Because mutual fund shares are generally easy to buy and sell, and the initial investment requirements are often accessible, investors may find it appealing to allocate a significant portion of their investable assets to mutual funds.

Here’s why you may want to reconsider.

Expense Ratios

Mutual funds often have high expense ratios. Expense ratios are the annual cost of managing the fund paid to the managers and expressed as a percentage of the overall investable asset.

For example, if the expense ratio is 1% and you invest $1,000,000, you will pay $10,000 annually in fees. While this may seem like a small amount, relative to the total investment, it’s helpful to compare it with the fees associated with other investment approaches, such as personalized, fee-only wealth management.

In many cases, wealth managers, like those at GDS Wealth Management, charge a similar fee. However, instead of that fee going solely toward managing a single fund, clients typically receive a broader range of services. These may include personalized investment advice, ongoing support, tailored financial planning, and access to portfolios aligned with individual goals and circumstances. For many investors, these benefits may offer more personalized value than paying an overhead fee for a mutual fund that is not customized.

Trading Costs

From brokerage commissions to bid-ask spreads, mutual funds can be laden with additional trading costs. These come on top of the existing expense ratios and can add up quickly to increase the overall fee you pay on your mutual fund investment.

If the mutual fund you select has a high turnover rate—meaning the fund managers buy and sell frequently to increase their diversification or stay current with the market—that means you will be paying significant trading fees, further reducing your overall returns.

Cash Drag

To meet redemptions and other obligations, mutual funds are required to maintain a portion of their assets in cash or cash equivalents. This is called “cash drag,” and can hinder the fund’s overall performance.  

In a rising market, which we have experienced for much of the past year, a cash drag can limit a fund’s ability to fully participate in market gains. Since cash holdings generally earn lower returns than other asset classes, this may result in your investment not capturing the full potential of available market returns.

Why Does It Matter?

To really understand the impact of the costs associated with mutual funds, consider how fees can accumulate over time. For example, a 1% expense ratio on a $1,000,000 investment means paying $10,000 annually in fees. Over decades, these costs can significantly reduce your overall returns, potentially amounting to thousands of dollars lost to fees alone. That’s why it’s important to evaluate how these charges may affect your long-term investment outcomes.

Now imagine you continued investing in this fund. Imagine how much is lost if your invested assets are over seven figures. Losing 25% of your total returns would be quite the loss.

Those fees don’t seem so insignificant now.

While mutual funds can certainly seem an attractive option, make sure you’ve done your due diligence and understand exactly what you’re paying for before you buy in.

If you have any questions about mutual funds or a personal investment strategy for your financial circumstances, contact our team of skilled financial advisers today. Call (469) 212-8072 or visit www.gdswealth.com.