(part 2 of 3)
This post is about a pit I fell into and stayed in for many years! I overlooked it because fee charts in prospectuses deceive by omission. Not until I attended a financial workshop in 2006 over in San Francisco, did I realize my mistake.
Prospectus fee charts don’t show “a percent of what?”
It’s not uncommon to look at the “Fees and Expenses” section of a prospectus and skim over fees without a thought of what they apply to. The amounts seem so little when you look at them.
As an example of a fee chart in all prospectuses, this table is from “Fund fees and expenses” in the prospectus for SWSCX Schwab Small-Cap Equity Fund ™)
Management fees 0.81
Distribution (12b-1) fees None
Other expenses 0.34
Total annual fund operating expenses 1.15
Less expense reduction (0.03)
Total annual fund operating expenses after expense reduction 1.12
It’s easy to glance at this chart without ever understanding exactly what these mutual fund fees apply to. From there it’s a short step to making the error of thinking you will pay the 1.12% fee only on your earnings.
But the difference between “earnings” and an “investment” is astronomical.
Here’s the difference when a 1% fee is taken out of an investment of $10,000 with annual earnings of 5%.
if you assume you are paying mutual fund fees only on earnings you get:
$10,000 at 5% = $500 in earnings
1% of $500 in earnings = $5 in fees
But, on an investment of $10,000 what you pay in fees is 1% of $10,000 or $100 in fees. And you do pay mutual fund fees on the whole investment each year, not just the earnings each year.
So what you actually pay on $10,000 at the end of year one is $100. That’s twenty times higher than what you might have thought you were paying, i.e., $5. And mutual fund fees keep going up as your earnings on your past investment totals compound each year.
Even very tiny differences in the amount of mutual fund fees charged for various funds can make a big difference in what you get back. This is especially true when you are investing a large amount of money in mutual funds over time.
I feel strongly that mutual fund prospectuses should tell us that mutual fund fees are on the entire investment, not just on its earnings!
Next time we’ll take a look at another misleading chart in the “Fees and Expenses” section of a mutual fund prospectus. This one is even more difficult to spot. And this one can cost you thousands or even tens of thousands of dollars!
Copyright © 2010 Nancy K. Humphreys All rights reserved. You are free to use material from Brucenomics in whole or in part, as long as you include attribution to Nancy K. Humphreys followed by a live link to http://brucenomics.com/.