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Best of Funds

In our previous report we spoke of how no-load funds help investors earn more money. Sales loads are one-time fees that investors pay either at the time of purchase or when units are redeemed. Whether front-end or back-end sales load funds, both reduce the investment returns. (Read: Skip Sales Load: 3 Top No-Load Funds to Buy

This time we will discuss about fund expenses. Fund expenses are paid indirectly from fund assets throughout the year. Lower charges will obviously allow larger share of the capital to be invested and also help investors in earning higher profits.

The win-win strategy should be a fund that carries very low expense ratio and no sales load. We will suggest investors such low-cost funds that also carry top Zacks Mutual Fund Rank. However before doing so, let us dig deeper into the analysis of expenses.

A Detailed Look at Expenses

Fund expenses cover operating expenses and fees.

The US Securities and Exchange Commission (SEC) summarizes the regular fund operating expenses by enlisting investment advisory fees, marketing and distribution expenses, brokerage and custodial fees, transfer agency, legal, and accountants fees into the category.

A fund’s prospectus will enlist certain charges under Annual Fund Operating Expenses. These charges include Management Fees, Distribution or Service Fees, Other Expenses and Total Annual Fund Operating Expenses. These expenses are charged indirectly as they are paid out of fund assets.

Separately, Shareholder Fees are fees and charges imposed directly on investors for transactions. These may include Sales Load, Redemption Fee, Exchange Fee, Account Fee and Purchase Fee.

Most investors are however acquainted with expense ratio. This is one of the most important parameters used while selecting a fund. This parameter is calculated by dividing operating expenses by the assets under management. These expenses include operating and administrative costs and 12 b-1 fees. The 12b-1 fees are operational expenses and range from 0.25% to a maximum of 1% of the fund’s net asset. The largest portion of these expenses is attributable to the fees paid to the fund managers or investment advisors.

Before moving on to sales load, it must be noted that many investors believe expense ratio to be the only charges levied. However, transactions costs, tax costs, soft dollar cost and cash drag may be part of the charges.

Transaction costs may be in the form of brokerage costs which may or may not be found in the prospectus. Transaction costs also include ‘spread cost’ which is incurred once a fund manager buys or offloads securities. It is the difference between the ask price and bid price.

Tax costs may be incurred whether or not an investor makes capital gains. If the fund manager changes the portfolio, tax must be paid on appreciated stocks. Soft dollar cost comes into play once the fund manager hires brokerage services. Fund managers may seek research or other services from brokerages. This cost is usually not made public.

Sales Load are usually one-time charges or commissions that investors need to pay either at the time of purchasing a fund or selling. Thus, it can either be front-end load or back-end loan charges. Front-end load charges are commissions paid at the time of initial purchase. It is usually deducted from invested amount, thus lowering the actual investment value. Back-end loads are paid at the time of offloading mutual funds. It is also known as contingent deferred sales charge or load.

Impact of Expenses on Investment Return

It is obvious that expenses will have an inversely proportionate impact on the net return. The chart below will show what an initial investment of $10,000 will return in 1, 3, 5, 10 years considering annual return of 10% with annual operating expenses of 0%, 0.5%, 1% and 2.5%, and front-end sales load of 0%, 2.5%, 5% and 7.5%, respectively. The ending value includes opportunity cost of expenses, loads and fees.

Annual Operating Expenses + Front-End Sales Load
0% + 0%
0.5% + 2.5%
1% + 5%
2.5% + 7.5%
 Calculated through MSN Money Calculator

The chart clearly shows how the return declines as the operating expenses move up.

If we look at the 10-year return, an investment of $10,000 will likely increase to $25,937 with no operating expenses charged. The same return comes down to $24,053, $22,284 and $18,626 with the addition of annual operating expenses of 0.5%, 1% and 2.5% and front-end sales load of 2.5%, 5% and 7.5%, respectively. The difference in return with no expense and 2.5% operating expense over the 10 years is $7,311.

Expenses on the Decline

A report published last year by Investment Company Institute notes that fees and expenses have been trending down since 1990. The study says that expense ratios for equity funds dropped to 77 basis points in 2012 from 99 basis points in 1990. That reflects over a 20% drop. Also, average expense ratio for hybrid funds are down to 79 basis points from 102 basis points over the same time frame. Expense ratios of Bond funds are down 31% to 61 basis points from 88 basis points in 1990.

3 Low-Expense & No-Load Fund Picks

Let’s take a look here at some cheap mutual funds that have expense ratio of 0.1% or lower, no sales load, high year-to-date returns and sport a Zacks Mutual Fund Rank #1(Strong Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

Vanguard Extended Duration Treasury Index Institutional Shares (VEDTX - MF report) uses indexing investment approach to track Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index’s performance. The fund invests a lion’s share of its assets in U.S. Treasury securities included in the index. The index that’s holds extended-duration zero-coupon U.S. Treasury securities are supported by the U.S. government and carry 20-30 years of maturity range.

The fund carries an annual expense ratio of 0.10% as compared to the category average of 0.56%. The fund carries no front-end sales load as compared to the category average of 3.75% and no deferred sales load as compared to the category average of 2.25%.

The fund has returned 22.9% year to date.

Fidelity Spartan Long-Term Treasury Bond Index Fund Fidelity Advantage (FLBAX - MF report) seeks high current income. The fund invests a lion’s share of its assets in securities listed in Barclays U.S. Long Treasury Bond Index. The fund tries to duplicate the performance of Barclays U.S. Long Treasury Bond Index by using statistical sampling techniques on the back of interest rate sensitivity and maturity among others.

The fund carries an annual expense ratio of 0.10% as compared to the category average of 0.56%. The fund carries no front-end sales load as compared to the category average of 3.75% and no deferred sales load as compared to the category average of 2.25%.

The fund has returned 13.3% year to date.

Nuveen Municipal Total Return Managed Accounts (NMTRX - MF report) seeks high total return along with current income. The fund invests most of its assets in interest-paying municipal bonds. These bonds are exempted from regular federal income taxes. The fund usually invests 10-30% in below investment grade municipal bonds, but may invest a maximum of 50% in those bonds. A maximum of 5% may also be invested in defaulted bonds.

The fund carries an annual expense ratio of 0% as compared to the category average of 0.88%. The fund carries no front-end sales load as compared to the category average of 4.00% and no deferred sales load as compared to the category average of 2.50%.

The fund has returned about 9.0% year to date.

To view the Zacks Rank and past performance of all Zacks #1 ranked mutual funds, investors can click here to see the complete list of funds.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Learn more about the Zacks Mutual Fund Rank in our Mutual Fund Center.

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