Buying from Brokers versus Fund Companies

 Many discount brokerage houses now offer their clients the option of purchasing shares in mutual funds directly from the brokerage house. Even better, most of these brokers don't charge any load or fees if a client buys a no-load fund. There are a few advantages and disadvantages of doing this.

Here are a few of the advantages.

     1.One phone call/Internet connection gets you access to hundreds of funds.
         2. One consolidated statement at the end of the month.
         3.Instant access to your money for changing funds and or families, and for getting your money in your hand   via checks (2-5 days).
         4.You can buy on margin, if you are so inclined.
         5.Only one tax statement to (mis)file.
         6.The minimum investment is sometimes lower.
And the disadvantages:

     1. Many discount brokerage supermarket programs do not even give access to whole sectors of the market, such as high-yield bond funds, or multi-sector (aka "Strategic Income") bond funds.
          2.  Most discount brokers also will not allow clients to do an exchange between funds of different families during the same day (one trade must clear fist, and the the trade can be done the next day).
          3. Many will not honor requests to exchange out of funds if you call after 2pm. EST. (which of course is 11am in California). This is a serious restriction, since most fund families will honor an exchange or redemption request so long as you have a rep on the phone by 3:59pm.
          4.You pay transaction fees on some no-load funds.
          5.The minimum investment is sometimes higher.
Of course the last item in each list contradict each other, and deserve comment. I've seen a number of descriptions of funds that had high initial minimums if bought directly (in the $10,000+ range), but were available through Schwab for something like $2500. I think the same is true of Fidelity. Your mileage may vary.

    •Mutual Funds - Fees and Expenses

Investors who put money into a mutual fund gain the benefits of a professional investment management company. Like any professional, using an investment manager results in some costs. These costs are recovered from a mutual fund's investors either through sales charges or operation expenses.

Sales charges for an open-end mutual fund include front-end loads and back-end loads (redemption fees). A front-end load is a fee paid by an investor when purchasing shares in the mutual fund, and is expressed as a percentage of the amount to be invested. These loads may be 0% (for a no-load fund), around 2% (for a so-called low-load fund), or as high as 8% (ouch). A back-end load (or redemption fee) is paid by an investor when selling shares in the mutual fund. Unlike front-end loads, a back-end load may be a flat fee, or it may be expressed as a sliding scale. A sliding-scale means that the redemption fee is high if the investor sells shares within the first year of buying them, but declines to little or nothing after 3, 4, or
5 years. A sliding-scale fee is usually implemented to discourage investors from switching rapidly among funds. Loads are used to pay the sales force. The only good thing about sales charges is that investors only pay them once.

A closed-end mutual fund is traded like a common stock, so investors must pay commissions to purchase shares in the fund. An article elsewhere in this FAQ about discount brokers offers information about minimizing commissions.

To keep the dollars rolling in over the years, investment management companies may impose fees for operating expenses. The total fee load charged annually is usually reported as the expense ratio. All annual fees are charged against the net value of an investment. Operating expenses include the fund manager's salary and bonuses (management fees), keeping the books and mailing statements every month (accounting fees), legal fees, etc. The total expense ratio ranges from 0% to as much as 2% annually. Of course, 0% is a fiction; the investment company is simply trying to make their returns look especially good by charging no fees for some period of time. According to SEC rules, operating expenses may also include marketing expenses. Fees charged to investors that cover marketing expenses are called "12b-1 Plan fees." Obviously an investor pays fees to cover operating expenses for as long as he or she owns shares in the fund. Operating fees are usually calculated and accrued on a daily basis, and will be deducted from the account on a regular basis, probably monthly.

Other expenses that may apply to an investment in a mutual fund include account maintenance fees, exchange (switching) fees, and transaction fees. An investor who has a small amount in a mutual fund, maybe under $2500, may be forced to pay an annual account maintenance fee. An exchange or switching fee refers to any fee paid by an investor when switching money within one investment management company from one of the company's mutual funds to another mutual fund with that company. Finally, a transaction fee is a lot like a sales charge, but it goes to the fund rather than to the sales force (as if that made paying this fee any less painful).

The best available way to compare fees for different funds, or different classes of shares within the same fund, is to look at the prospectus of a fund. Near the front, there is a chart comparing expenses for each class assuming a 5% return on a $1,000 investment. The prospectus for Franklin Mutual Shares, for example, shows that B investors (they call it "Class II") pay less in expenses with a holding period of less than 5 years, but A investors ("Class I") come out ahead if they hold for longer than 5 years.

In closing, investors and prospective investors should examine the fee structure of mutual funds closely. These fees will diminish returns over time. Also, it's important to note that the traditional price/quality curve doesn't seem to hold quite as well for mutual funds as it does for consumer goods. I mean, if you're in the market for a good suit, you know about what you have to pay to get something that meets your expectations. But when investing in a mutual fund, you could pay a huge sales charge and stiff operating expenses, and in return be rewarded with negative returns. Of course, you could also get lucky and buy the next hot fund right before it explodes. Caveat emptor.

     •  Money-Market Funds

A money-market fund (MMF) is a mutual fund, although a very special type of one. The goal of a money-market fund is to preserve principal while yielding a modest return. These funds try very, very, very hard to maintain a net asset value (NAV) of exactly $1.00. Basically, the companies try to make these feel like a high-yield bank account, although one should never forget that the money-market fund has no insurance against loss.

The NAV stays at $1 for (at least) three reasons:

1. The underlying securities in a MMF are very short-term money market instruments. Usually maturing in 60 days or less, but always less than 180 days. They suffer very little price fluctuation.
2. To the extent that they do fluctuate, the fund plays some (legal) accounting games (which are available because the securities are so close to maturity and because they fluctuate fairly little) with how the securities are valued, making it easier to maintain the NAV at $1.
3. MMFs declare dividends daily, though they are only paid out monthly. If you totally cash in your MMF in the middle of the month, you'll receive the cumulative declared dividends from the 1st of the month to when you sold out. If you only partially redeem, the dividends declared on the sold shares will simply be part of what you see at the end of the month. This is part of why the fund's interest income doesn't raise the NAV.

MMFs remaining at a $1 NAV is not advantageous in the sense that it reduces your taxes (in fact, it's the opposite), it's advantageous in the sense that it saves you from having to track your basis and compute and report your gain/loss every single time you redeem MMF shares, which would be a huge pain, since many (most?) people use MMFs as checking accounts of a sort. The $1 NAV has nothing to do with being able to redeem shares quickly. The shareholders of an MMF could deposit money and never touch it again, and it would have no effect on the ability of the MMF to maintain a $1 NAV.

Like any other mutual fund, a money-market fund has professional management, has some expenses, etc. The return is usually slightly more than banks pay on demand deposits, and perhaps a bit less than a bank will pay on a 6-month CD. Money-market funds invest in short-term (e.g., 30-day) securities from companies or governments that are highly liquid and low risk. If you have a cash balance with a brokerage house, it's most likely stashed in a money-market fund.

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