When purchasing mutual funds we are cautioned to read the prospectus, look at past performance, check out the fund manager’s record and see what their expense ratios have been.
We are also told that we should not buy funds with expenses exceeding 1% to 1.5%. When you ask the fund salesman (don’t forget he’s a salesman) he will assure you that the fund expenses are whatever is shown in the prospectus. He is telling you the truth, but not the whole truth, according the Securities and Exchange regulations. In many cases he has left out a big chuck of expenses.
The 1.5% expense means you are paying $150 each year of every $10,000 you have invested with that fund. The lower the expense is the more of your money is at work. As a fund becomes larger meaning they take in more money the expense ratio should drop, but it rarely does. he fund manager must make 1.5% to have your money stay even.
If you can find your way around the Securities and Exchange Commission internet web site you will find that the definition of expense ratio leaves out commission charges. Many funds will turn over their portfolio by 100% in a year. Obviously they are not going to buy and sell at no charge. The floor broker must be paid a commission for each share that is executed.
Sometimes brokerage fees are purposely inflated and the broker kicks back favors(they don’t call it that) such as research information, free computers and other favors. Been to the Hampton’s or Hawaii for that all-expense weekend seminar? Course not.
The SEC does not require that this commission cost be disclosed as an expense. Why? Their answer is pure government hokum, “We exclude brokerage costs because we have always excluded brokerage costs”. This is the SEC that is supposed to be the watchdog for the investor.
Leaving out this important fact will hide another .25 to .50 cents or more in some cases in expenses that you are paying for. When you call the fund to ask if their brokerage commissions are included the person to whom you are speaking probably won’t understand and will give you the standard answer that the number shown in the Prospectus is correct. Getting a true answer is like pulling an impacted wisdom tooth. If you can get one.
Brokerage commissions are known to the penny and could easily be included in the prospectus, but these “soft dollars” as they are known are not made public to the investors seem to disappear.
Fund managers say these costs are insignificant and that investors should look at the fund’s performance. If they did that and really understood what they were looking at they probably wouldn’t buy 90% of the domestic stock funds.
This is just another example of how the investor has the wool pulled over his eyes and another reason I find prospectuses worthless.
Al Thomas’ best selling book, “If It Doesn't Go Up, Don't Buy It!" has helped thousands of people make money and keep their profits with his simple 2-step method. Read the first chapter and receive his market letter for 3 months at http://www.mutualfundmagic.com and discover why he's the man that Wall Street does not want you to know. Copyright 2005