Carlson critiques funds: no-load stocks vs. no-load mutual funds

Black Enterprise, Oct, 1995 by Charles B. Carlson

From an NLS Perspective. I won't say that no-load stocks, as a group, will outperform no-load mutual funds over time. I will say that investors who ignore no-load stocks for no-load mutual funds may be overlooking some attractive long-term capital-gains performers while relegating their investment funds to subpar performance.

MYTH: INVESTIGATING IN NO-LOAD FUNDS IS "NO-COST" INVESTING

Much of the popularity of no-load funds is the fact that they can be bought without a sales fee. However, to say that investing in no-load funds is "no-cost" investing is simply not. true. In many cases, the costs of. investing in no-load mutual funds are greater than the costs of investing in individual stocks, especially no-load stocks. The problem is that most investors don't realize it since funds deduct expenses from your holdings, which means you never actually write a check to pay expenses. This may be less obvious, but it is no less painful to portfolio performance.

The sales, or "load," fee is only the tip of the fee iceberg in terms of the costs of investing in mutual funds:

* Annual management and administrative fees. These are the fees that all no-load funds charge to manage and administer the assets. Rates differ from one fund group to another and across types of funds. However, it is not uncommon for equity funds, especially those investing in foreign securities, to have annual management fees of well over 1% and more than 2% in some instances. Administrative fees may include such things as account setup fees, annual account maintenance fees, telephone redemption fees, and check redemption processing fees.

* 12b-1 fees. A number of no-load mutual funds charge 12b-1 fees to help defray expenses. These fees have become more regulated in recent years, although 12b-1 fees can still consume up to 0.75% of your assets.

* Back-end loads. Since mutual funds realize that investors don't like up-front load fees, they have become adept at building less conspicuous fees into the system. One such fee is a "back-end" or redemption fee. Most back-end load fees apply if a fund holder sells shares within five years. The fees decline the longer the fund shares are held and usually disappear if the fund is held for longer than five or six years.

When you add all of these fees together, it's quite possible that a no-load mutual fund may be charging you 2% to 3% per year in fees. That translates to annual fees on a $10,000 investment of $200 to $300 per year. That's $200 to $300 on which you'll never earn a dime in the future.

While mutual funds have been dropping "load" fees, management and administrative fees are increasing despite record dollar amounts under management. Logic says that a larger amount of money in a fund would create economies of a scale in managing and administering funds, causing fee expense ratios to decline. However, the opposite has occurred. Why? Because fund investors, by and large, have no idea how much they pay in annual fees, thus allowing funds to raise these "hidden" fees aggressively.