Be alert: Fees, taxes eat into fund returns

If you've ever bought the Shed-No-Mor cat sweater or the Swiss Army Fork from a late-night television commercial, you know that some things aren't quite what they are advertised to be.

If you look at what you've actually earned in your mutual fund over time, you might be surprised to find that your returns don't match what you find advertised. While you can't control what Mr. Market will give you, you can control how much you earn from your fund.

Let's look at the American Funds Growth Fund of America, one of the largest funds in the universe. The A shares - the largest share class, and the one most likely sold to individual investors - have gained an average 4.17 percent a year for the past decade. That may not sound like much, but it's better than the Standard & Poor's 500-stock index, up an average 2.82 percent in the same period.

To put this in some perspective: A $10,000 investment in the fund would have gained $5,046 in 10 years.

If you paid the fund's maximum 5.75 percent sales charge, however, your total return was 3.55 percent, according to Lipper, which tracks mutual funds. Your gain has now shrunk to $4,174.

But wait, there's more - because it gets worse. Most funds distribute income and capital gains at least once a year. You owe taxes on those distributions. Assuming you were in the highest tax bracket, your after-tax return would be 3.21 percent, according to Lipper.

And if you had sold the fund after 10 years and paid taxes on your gains, you'd be left with a 2.96 percent average annual gain.

So: You invested $10,000 in a taxable account, paid the sales charges and paid taxes on distributions and gains. Your $10,000 is now $13,387. At that rate, you'd double your money in about 24 years.

What's an investor to do?

You could fervently wish for higher returns from the stock market. While you're at it, you may as well ask for an albino pony, too. You really can't do anything about your future returns from the stock market.

But you can reduce your costs as much as possible. One easy way, of course, is to buy a no-load fund. You pay no commission, but you get relatively little advice. If you absolutely must invest through a broker, you can save money on commissions by learning the different ways to reduce them.

Typically, the more you buy of a load fund, the less you pay in commissions, or loads. The sales charge for the Growth Fund of America drops to 5 percent if you invest $25,000, and 4.5 percent if you invest $50,000.

You can often combine holdings within one fund family to reach the break points. A complete list of ways to lower your load is at www.finra.org.

Loads on nearly all funds vanish at $1 million, which might be rich for your blood, but probably isn't for your 401(k) savings plan. If you're dying to invest in a popular loaded fund, your 401(k) might offer it at no load - and, even better, with institutional fees, which are nearly always lower than retail fees.

You can also control taxes to some extent. When you invest in a tax-deferred account, your earnings compound tax-free. But be careful. If you invest in a stock fund in a 401(k) or IRA, your gains will all be taxed at your ordinary-income rate, which is probably higher than the capital-gains rate, currently a maximum 15 percent.

If you can, open a Roth IRA: Although you invest with after-tax money, your gains aren't taxed at all.

Reducing costs and taxes can make a tremendous difference in your returns over time. And if you want a sure-fire way to increase your balances, invest more. Unlike the things you see advertised on late-night television, increasing your savings rate always works wonders.

by John Waggoner USA Today May. 29, 2011 12:00 AM




Be alert: Fees, taxes eat into fund returns