"401(k): Hidden Fees" Investigative Report on Bloomberg TV

An investigative report on hidden fees in 401(k) plans premiers on Bloomberg TV tomorrow night (Thursday, June 19 at 7PM and 9PM EST).

The report will cover how fees are eating away at 401(k) balances without plan participants even realizing it and how even financial experts have trouble uncovering these fees. If you have a 401(k) plan, and especially if you sponsor one, be sure to tune into what we're sure will be a truly enlightening report.

To get more information go to Bloomberg TV and look for 401(k): Hidden Fees - What's hiding in the fine print of your 401(k).

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Focus On Fees: The Sales Load

When it comes to mutual funds, a load is another name for a sales fee that investors may pay to a mutual fund company for buying or selling shares of a fund. Think of it as a commission that the fund company gives to brokers who sell the fund to investors.

A load mutual fund charges this fee to investors, a no-load fund does not.

Loads usually cost between 4% - 8% which comes directly out of investors’ assets. The Financial Industry Regulatory Authority (FINRA) has capped sales loads for mutual funds at 8.5%.

There are two main types of loads:

Front-end loads are paid when you purchase shares in the fund. If you invest $100,000 in a fund with a 6% front-end load, you will pay $6,000. That means only $94,000 of your money will actually get invested in shares of the mutual fund.

Back-end, or deferred loads, are paid when you sell or redeem shares of a fund. Back-end loads are usually based on either the amount of your initial investment or the value of the investment when you sell shares – whichever is lower. If you invest $100,000 in a fund with a 6% back-end load, the full $100,000 gets invested in the fund. When you sell, however, you will pay $6,000 as long as the value of your investment is still $100,000 or more. If the value of your investment has dropped to $90,000 when you sell, the sales charge will be $5400. This is not always the case, however. You could end up paying a deferred load on the full amount of your investment if it increases in value.

One last note on back-end loads. The amount of the load may be affected by how long you own the fund. For example, the load could be 6% if you sell within the first year then drop to 5% if you sell in the second year and go away completely after some timeframe. To find out how the deferred loads are calculated check a fund’s prospectus. (Or, better yet, just stick with no-load funds so you don’t have to worry about this.)

There is a third, less common type of load - the constant load fund. Constant load funds charge an annual sales fee to investors. The loads on these funds tend to be lower than those of front-end and back-end mutual funds. To offset these “lower” fees, however, these funds will usually have higher expense ratios than those with front or back end loads.

As is the case with expense ratios, it’s pretty easy for investors to find out what the load is for a mutual fund. You can find it in the fund’s prospectus or on your favorite finance site.

Let’s look at the page for the Vanguard Small Cap Index fund on Google Finance. On the right side of the page under “Key Statistics” there is a line item for “Front load” and “Deferred load.” In the case of this fund, there are no sales charges so it is considered a no-load fund.

Next, let’s look at the page for the Fidelity Advisor Small Cap Value A fund. Notice that next to “Front load” in the Key Statistics section this fund has a load of 5.75%.

Lastly, we’ll look at the page for the Fidelity Advisor Small Cap Value B fund. This is a back-end loaded fund, as seen by the 5% listed by “Deferred load” in the statistics.

(Quick side note: funds that are designated as having Class A shares usually have a front-end load, Class B shares usually indicates a fund with a back-end load. In the case of the Fidelity funds above, they are basically the same funds containing the same investments. The only difference is when they charge the load to investors.)

The most important lesson for investors when it comes to loads can be illustrated by looking at this chart. It compares the returns for the funds we looked at above. As you can see, the no-load Vanguard index fund greatly outperformed the two loaded Fidelity funds. In fact, over the past 5 years, if you had invested in the Vanguard fund, you’d have over 3 times as much money in your account than if you owned either of the Fidelity funds.

In all fairness, there are probably some loaded small cap value mutual funds that have outperformed the Vanguard index fund. However, while Wall Street and money managers would like you to believe otherwise, paying a sales load for a mutual fund does not guarantee a higher return. There is no evidence that load funds can outperform no-load funds.

Paying a load does guarantee two things:

1. Your broker will make more money than if you bought a no-load fund.

2. The fund will have to outperform the market – and then some – in order for you to just match the returns of an index fund.

When it comes to sales loads on mutual funds, it’s best to follow the advice most commonly given by everyone except those who sell loaded mutual funds: avoid them and stick to no-load funds.

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Warren Buffett Big Bet Against Hedge Funds

An interesting wager between Warren Buffett and Protégé Partners LLC, a money management firm that runs funds of hedge funds, became public recently.

Buffett has long held that the best investment for most investors in the simple index fund. He believes, as do we at Blue Ocean Portfolios, most investors will achieve better returns over the long haul by NOT paying money managers to actively manage an investment portfolio.

Protégé disagrees.

So Buffett and Protégé each put up about $320,000 on a wager over whether Vanguard's S&P500 index fund will outperform five funds of hedge funds selected by Protégé over the next 10 years. The winner will be decided based on total average returns net of all fees, expenses, and costs. Proceeds of the bet go to the charity of the winner's choice.

The question for you as an investor is: Would you bet against Warren Buffett?

For more details on the wager see the CNN Money article here.

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Focus on Fees: The Expense Ratio

To kick off our “Focus on Fees” series, we’ll take a look at one of the most common fees investors will encounter: the expense ratio.

If you own a mutual fund, you are paying this fee. It’s basically your cost of owning a mutual fund (however, as we’ll see, it doesn’t tell the whole story when it comes to expenses for a mutual fund). The expense ratio reflects the percentage of a fund’s assets that go toward its operating expenses (ie. management fees, distribution fees, etc.).

For example, if a fund’s annual expenses are $1.5 million and its assets under management (all the money that investors have invested in the fund) are $100 million, the fund’s expense ratio is 1.5%.

Expense ratios are taken directly out of the investor’s pocket. Since they eat into your returns, it’s important to know what the expense ratios are for the funds you own. It’s also important to understand that expense ratios can vary widely between funds.

The average mutual fund’s expense ratio is around 1.5%. However they can range from under 0.20% for low cost Vanguard index funds to well over 3% for some actively managed funds.

You might assume that if you pay more, you’ll get better returns. That would be a bad assumption. In fact, in any given year, about 80% of actively managed mutual funds fail to beat their benchmark.

Unlike many fees which can be hidden and difficult for investors to find, it’s easy to find the expense ratio for any mutual fund. Simply go to your favorite finance website and type in the fund’s ticker symbol.

In Google Finance, for example, at the very top of the screen you’ll find an area called “Key Statistics.” The expense ratio for your fund will be listed there. Here’s a link to the Google Finance page for the Vanguard Total Stock Market Fund. You can see that the expense ratio for this fund is a very low 0.19%.

That does it for the basics you need to know about expense ratios. As we mentioned, however, they don’t tell the whole story of what your costs are for owning a mutual fund. More on those costs in future “Focus on Fees” installments.

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