Ever heard of SMART goals? The “M” stands for “measurable.” For example, a writer might have a goal stating: “I will write every day.” That's not a SMART goal. It doesn't say how much I will write every day. Writing “Wish you were here!” on a postcard would meet this goal. It would not, however, satisfy the goal's objective (to become a better writer). A SMART goal might say: “I will write 500 words a day.” But does this still meet the objective? Not if I write the word “SMART” 500 times. A better SMART goal would be “I will write a chapter a day.” Just because we can measure something doesn't mean it's relevant to our purpose.

The temptation to quickly measure scours our ability to correctly assess the impact of fees on mutual fund productivity. We don't buy mutual funds to spend less money, which the unfortunate focus on fees implies. We invest in mutual funds to make more money. A “productive” mutual fund makes us more money (not necessarily the “most” money).

There lies the crux, or, more appropriate for Valentine's Day, the “heart” of the matter. Like any other company, a mutual fund exhibits a certain cost of doing business (e.g., regulatory, compliance, and professional management costs). These costs are added together to create the fund's “expense ratio.” This is located on page 2 or 3 of the fund's prospectus under the heading “Risk/Return Summary: Fee Table.” Moreover, that fee table provides an important clue to those measurable fees that matter.

Want to impress a retirement saver? Show them how to pick out the fees that matter to a mutual fund's productivity. Regulators have made this easier than you think. Under the fee table, the SEC requires all mutual funds to create two lists. The first one is called “Shareholder Fees” (fees paid directly from your investment). These are fees that directly detract from a saver's initial investment and are over and above the expense ratio. As such, they should be listed as “none” across the board.

The next list is titled “Annual Series' Operating Expenses” (expenses that you pay each year as a percentage of the value of your investment). This one requires a bit of work to decipher. Note the use of the term “expense” instead of “fees.” Most of the expenses listed here reflect the cost of doing business. There is one line item, though, that raises a red flag. It's labeled “Distribution [and/or Service](12b-1) Fees.” Savers want this to be “none” also.

Studies show mutual funds without “none” in these categories generally exhibit poorer investment results than their pure no-load counterparts. (I haven't mentioned revenue sharing, only because the SEC does not currently require that to be broken out.)

Help a retirement saver get to the heart of mutual fund fees. Show them how to discover the ones that matter most.

Instant Insights /

Mutual fund fees: the heart of the matter

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