Understanding Bond Mutual Fund Fees

 

Typically, there are three potential bond mutual fund fees.

  1. Load fees (which primarily go to the salesperson)
  2. Transaction fees (which go the brokerage firm)
  3. Fund expenses (which go to the mutual fund company)

Here is a detailed explanation of each.

Load Fees – Avoid Mutual Funds WIth Load Feeds

There are two main types of load fees, a front-end load which occurs when you buy shares of a mutual fund, and a back-end load which occurs when you sell shares. A front-end load is the most common type. These fees can be as high as 5.0%, and are generally not lower than 1.0%. For example, the PIMCO Total Return Fund A Shares have a front-end load fee of 3.75%. This fee gets taken out immediately of the initial investment and generally goes to pay the financial advisor “recommending” the fund.

If a financial advisor recommends buying a mutual fund with a load fee, Learn Bonds recommends changing your advisor. The major online brokers (such as E-Trade) all enable you to buy thousands of mutual funds with no load fees. Usually, mutual funds with load fees have a class of shares with no load. In the case of the PIMCO Total Return Fund, one can buy the D shares with no load.

Brokerage Fees – These Fees are One Time

Similar to when you buy a stock or bond through a brokerage firm, sometimes there is a fee for processing the bond mutual fund transaction. However, there is often no fee when going through an on online broker. They all have preferred mutual funds where there is no fee for buying or selling shares of the mutual fund. If one does not choose a preferred fund, the fees with online brokers are generally under $76 to buy and free to sell.

Expenses – These Fees Are Recurring and Very Important

The average expense fee (called the annual expense ratio) for bond mutual funds tracked by Morningstar is 0.998%, basically 1.00% of the assets of the fund.  The average is slightly higher for taxable bond funds at 1.01% and slightly lower for municipal bond funds at 0.97%. In this low interest rate environment, expense fees can substantially reduce returns. If one thought of the expense fees as reduction of income (yield), the expense fee for many popular bond mutual funds would reduce yields by about 28%.

There is a good deal of variation in annual expense ratios. For bond mutual funds, the expense fees range from 0.02% to 3.18%.  Most people will not qualify for the lowest fees which have conditions like $1 million minimum investments. However, one should be able to find a great funds with a fee between 0.40% and 0.75%. The PIMCO Total Return Fund D shares  had a 0.75% annual expense fee last year.

Expense fees include the management fees, administrative fees, and 12b-1 fees (for marketing and distribution). They don’t include the loads fees or brokerage fees described above.

Where can you find information on fees?

We recommend visiting Morningstar.com. They provide great information on expense fees when you know the symbol for a fund.  Keep in mind the Following:

  • Expenses are accrued to fund on a daily basis. An investor cannot “game the system” to avoid paying expenses by adding or withdrawing funds on specific dates.
  • The difference between Gross and Net Annual Expense Ratios. For new mutual funds, the mutual fund company may provide a limited time fee or reduction waiver (typically a year) to encourage deposits, which result in the Gross (before the waiver) being higher than the Net (after the waiver).
  • The difference between the annual report and prospectus: expense ratios. The annual report is audited and provides information on the funds historical expenses. The prospectus is not audited and tends to provide a more accurate picture of expected expense ratio going forward.

This lesson is part of our Free Guide to the Basics of Investing in Bond Funds. Continue to the next lesson here.

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