Defining Mutual Fund Costs

Mutual fund costs fall into two broad classes: 
sales charges (known as "loads") and expenses 
incurred in the fund's operation (operating expenses). 
Not all mutual funds impose loads, but all funds have 
operating costs that are deducted from fund earnings. 
In addition to these two kinds of costs, there are 
some types of account fees that you may also encounter. 

Loads 

These sales charges come in three varieties: front-end 
loads, back-end loads, and level loads. Front-end loads 
are paid when you purchase fund shares; back-end loads 
are paid when you redeem (or sell) fund shares; level 
loads are paid annually and included as marketing and 
distribution expenses. 

Front-end loads range between 3% and 8.5% of your investment, 
effectively reducing the amount you initially invest.* 
You may also pay these loads when you reinvest dividends 
in additional shares. Back-end loads may either be a percentage 
of the amount you redeem or a flat fee. A back-end load (or 
deferred sales charge) can amount to 5% to 6%* of the proceeds 
of any redemption made during the first year. The fee usually 
decreases by a certain amount over a specified period of time, 
for example, by one percentage point a year for a period of 
up to six or seven years after the original purchase. 

Level loads may be as much as 0.75%* per year on a continuing 
basis. These charges are deducted annually from fund assets 
as marketing and distribution costs. They are paid as commissions 
to brokers and financial advisers, and they are typically 
reported as part of the fund's expenses. Sometimes these 
charges are combined with front-end or back-end loads. 

Mutual funds that have no sales charges are known as "no-load" 
funds, while funds that charge 1% to 3% of the amount you invest 
are called "low-load" funds.

Operating Expenses 

The term operating expenses refers to the cost of operating 
a mutual fund. These expenses include advisory fees paid to 
investment managers and expenses incurred for fund administrative 
services. Usually expressed as an annual percentage of the fund's 
average net assets and called an "expense ratio," these costs 
typically may range from under 0.20% of a fund's assets (or $2 
per $1,000) to more than 2% (or $20 per $1,000 of fund assets).* 

Note: A fund's sponsor may temporarily waive its management 
fee or absorb all operating expenses to enhance the fund's 
current yield. This has become a common practice with new 
mutual funds. Investors should be alert for it when comparing 
fund yields. 

Some mutual funds also add a fee known as a 12b-1 fee, which 
is a method of charging marketing and distribution-related 
expenses directly against fund assets. The term "12b-1" refers 
to the 1980 U.S. Securities and Exchange Commission (SEC) 
rule that permits this practice. A fund is required to disclose 
a 12b-1 fee in its stated expense ratio. 

There is no legal limit to the 12b-1 fees that a fund may charge, 
but the fees normally run between 0.25% and 1% of the fund's 
average annual net assets.* At 1%, this means a charge to the 
investor of $10 per $1,000 in fund assets per year.

The term level load describes that portion of 12b-1 fees 
used to compensate brokers and investment advisers for selling 
shares of the fund. If a fund charges a 12b-1 fee in excess 
of 0.25%, it may not call itself a "no-load" fund even if 
it has no other sales charges. This amount, like all operating 
expenses, is deducted directly from a fund's earnings. 

Note that none of these fees relates in any way to the investment 
management of a fund, good, bad, or otherwise. Yet some investors 
may wrongly believe that higher fees always equate to "better" 
investment management. 

Other Fees 

Mutual funds may charge many other types of fees, including 
the following, according to Vanguard estimates: 

Exchange fee. A charge, typically between $5 and $25, assessed 
when you exchange shares from one fund to another within the 
same fund family. 

Account maintenance fee. A charge, typically between $10 and 
$25 per year, that may be assessed on all accounts, but is 
generally charged against accounts having balances below a 
stated dollar amount. This charge is meant to fairly apportion 
expenses among shareholders, because low-balance accounts are
relatively expensive to maintain. 

Transaction fee. A charge, typically 1% or 2%, that may be 
assessed on either purchases or redemptions. These fees are 
not sales loads, because they are not used to compensate 
salespeople. Rather, transaction fees are paid directly to 
the fund itself to help defray the costs associated with 
buying and selling securities. 

*Source: Lipper Analytical Services, Inc.