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A reader recently sent us an e-mail to research some mutual funds for her (you can send questions by e-mail to: myquestion@msfiscallyfit.com ; we will try to answer all questions depending on e-mail volume). She was concerned with the commission charges and the deferred sales charges (the fee she would pay when she sells her fund within a specified period of time). After researching the funds and the fund family, it seemed that investors were confused by "The Smoke and Mirrors of Mutual Fund Returns". We decided it was necessary to educate our readers to help them evaluate the true returns of their mutual fund investments.
As we have stated before in our articles, sales commissions, up-front (front-end fees) and deferred sales load (back-end fees), 12b-1 fees (marketing fees), management fees and operating fees need to be considered in calculating true mutual fund returns because they all reduce your overall investment performance.
For our reader, we researched different AIM mutual funds and found them all to be solid performers, delivering from a 20% -25% average annual return. The 20% - 25% return matches the performance of a S & P 500 Index mutual fund. This is important because the S & P Index is the standard to which all mutual funds are compared and if your mutual fund does not at least meet or exceed the return of the S & P 500, then you should just invest in a S & P 500 Index mutual fund. Surprisingly, only about 75% of all mutual funds beat the S & P 500 (this is a little-known fact).
There are some specific characteristics about the AIM funds we would like to point out to help you become more informed when researching your own investments and not be fooled by the "Smoke and Mirrors of Mutual Fund Returns". We did notice that the operating expense ratios of the AIM funds are a little high. The 1999 average is about 1.45%. In particular, the AIM Value and the AIM Dent Demographics (a new fund) have expense ratios of 1.80% and 2.29%, respectively. The expense ratio measures how much you pay each year for management, marketing (known as 12b-1 fees) and operating expenses. These expenses are deducted out of your investment gain, thus lowering your overall return. Each mutual fund has a different expense ratio – some very low like S & P 500 Index funds (expenses as low as 0.18%) to some very high like international funds which are harder to manage. If possible, look for mutual funds that have low expenses to help increase your returns.
Another characteristic we noted was that the AIM Value Fund has a high turnover ratio which may create more annual taxable income, if the funds are in a taxable type account (not applicable in nontaxable accounts like IRAs). As you may already know, the IRS requires you to pay taxes on any capital gains and dividends the fund generates during the year, regardless of whether you receive the gains/dividends in cash or the gains/dividends are reinvested. Mutual funds with high turnover ratios create higher taxable gains resulting in higher taxes for the investor. Each fund has different turnover rates – some very low like S & P 500 funds and some high like very volatile technology/Internet funds. Once again lower is better. One thing to remember is not to pass up a high performing fund because of high fees and/or high turnover. Many funds returning 40% plus may sport high fees/turnover, but it's ok. However, if your fund has an average return and you have a choice of investing in a similar type fund with a lower expense and turnover ratio, go for the lower expense/turnover, because your overall "after tax" return will be higher. You'll keep more money in your pocket.
When evaluating a mutual fund, all else being equal, a no-load (up-front or deferred sales charges) fund with annual expenses below the average of 1.45% (1999 average) will outperform a more costly "load" fund. Unless you are convinced that the more expensive mutual fund has higher potential than its less expensive competition, there is no point in starting off in the negative. MsFiscallyFit says, "A dollar saved is a dollar earned"!
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