Friday, February 6, 2004

Figuring out mutual fund fees not so simple

By Lisa Singhania
The Associated Press

NEW YORK - Ask most Americans how much they pay for electricity, water or cell phone service, and all they need to do is look at a monthly bill for the answer.

Mutual fund investors don't have it so easy. Although the Securities and Exchange Commission requires funds to disclose how fees are assessed, it can be tricky for investors to find out precisely what they're paying on an individual basis.

"The average investor doesn't know how much he is paying and doesn't have time to figure it out. It's very complicated," said John Freeman, a University of South Carolina law professor who has written extensively about mutual fund fees.

The primary source of information investors have about fees is the fund prospectus, a document required by the SEC. The prospectus' fee table breaks down fees into two categories: shareholder fees, which come directly out of a shareholder's pocket (such as a sales charge when shares are purchased) and annual operating expenses, which are calculated as a percentage deducted from a shareholder's account. Not all funds assess all fees, but the prospectus includes discussion of both categories.

The prospectus also includes a hypothetical example of how much fees will cost over a certain number of years, assuming a 5 percent return on a $10,000 investment.

The SEC contends that this type of information allows investors to make apples-to-apples comparisons between other funds, but some critics say a more useful tool would be customized breakdowns for individual shareholders.

"I think it would be a very good thing for funds to report individually tailored fees," said Chris Traulsen, an analyst at Morningstar. "Most investors don't have any idea what they're paying."

Consult prospectus

By consulting the prospectus, investors can get a rough idea of what they're paying. But an examination of three well-known, growth-oriented funds shows the variation among fees and the difficulty in making a true comparison:

According to Fidelity's Web site, this fund has a total expense ratio of 1.03 percent. That means the fund - and, subsequently, each individual investor - pays 1.03 percent of assets in expenses.

According to the fee table in the prospectus, Contrafund investors pay no direct shareholder fees, such as sales charges. The annual operating expenses section of the table breaks down the expense ratio to show that shareholders pay 0.81 percent of their assets in management fees and 0.22 percent in "other expenses."

Management fees are those paid to the fund's investment adviser for investment portfolio management, as well as any other management and administrative fees not part of the other expenses category, according to the SEC. Other expenses can include shareholder service and legal costs.

The prospectus also provides the SEC-required example of how much a shareholder would pay on an investment of $10,000 that had a return of 5 percent annually: $402 if you sold all of your shares at the end of one year; $618 after three years; $852 after five years and $1,522 after 10 years.

A potential low-balance account fee of $12 is not included in the fee table. Investors have to look in the policies section of the prospectus to find out about the annual assessment on some accounts of less than $2,500.

The bottom line: Contrafund shareholders should first calculate what 1.03 percent of their fund assets is, and then add in the low-balance account fee if applicable. If they bought the fund through an adviser, there may be other fees to consider, although those fees are not in the prospectus because they do not directly involve the fund.

This large-cap stock fund has an expense ratio of 0.75 percent to 1.55 percent depending on whether an investor buys class A, B, C or F shares.

Fee structures vary

The different share classes reflect different fee structures; for example, class A shares usually involve a front-end sales charge, class B shares usually involve a charge when fund shares are sold. Fund companies say different share classes give investors more flexibility; critics say they are confusing and further cloud the issue.

The shareholder fees for this fund vary according to share class. Class A shares carry a sales charge of up to 5.75 percent when shares are bought, while class B and C shares carry charges of as much as 5 percent and 1 percent, respectively, when the fund shares are sold.

The annual operating expenses show that although the fund's management fees are a constant 0.31 percent, the charge for distribution and service fees, also known as 12b-1 fees, and the "other expenses" category vary by share class.

So does the hypothetical example of fees. With an annual 5 percent return on $10,000 after one year, the fees range from $77 to $656 depending on share class and whether you sell your shares; after 10 years, the range is between $930 and $1,845.

The bottom line: American Funds Growth Fund shareholders need to figure out what share class they have, and then use the appropriate expense ratio to assess what portion of their assets are going to fees. They then need to add in the cost of any sales charges - although some of those charges won't be calculable until after the shares are sold. Also, ask about your adviser's compensation.

Restitution paid; fees lowered

AllianceBernstein funds are managed by Alliance Capital Management, which recently agreed to pay $250 million in restitution and fines and reduce its fees by $350 million to settle charges of improper fund trading. Specific fee reductions have yet to be determined.

As with The Growth Fund of America, the annual operating expense varies according to the share class - ranging from 1.36 percent to 2.41 percent. The management fee is a constant 0.75 percent, but 12b-1 fees vary from zero percent to 1 percent and the "other expenses" category ranges from 0.61 percent to 0.66 percent.

The amount investors pay directly depends on the share class. There is a front-end sales charge of up to 4.25 percent on class A shares, and a deferred charge of up to 4 percent on class B shares and up to 1 percent on class C shares - although those charges may not apply, depending on the size and duration of your holdings.

After one year, a shareholder with a $10,000 investment at a 5 percent annual return would pay from $138 to $644 in fees. After 10 years, the range is $1,635 to $2,716.

The bottom line: As with the American Funds Growth Fund, the prospectus identifies the appropriate shareholder fees and expense ratio for each share class. To do the math, multiply your assets by the appropriate expense ratio, and then add on the appropriate fees. Also, make sure you understand how your adviser gets compensated.

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