Percentage of General Funds Outperformed by S&P 500

Bogle, Common Sense on Mutual Funds : New Imperatives for the Intelligent Investor, p. 119.

In any case, this is a short explanation on some of the fees/costs that you need to be aware of...

Mutual fund sales charges, also called loads, are one of the things that you should never pay when purchasing a mutual fund.   If you're reading this, you're certainly able to pick mutual funds that will provide better net returns than if you pay somebody else to pick them for you.

Mutual funds come in two broad categories.   Those that have a sales charge and those that do not.   Those that have a sales charge are called load funds and those that do not are called no-load funds.   When a broker recommends a fund for one of her clients to buy, that fund will be in all probability a load fund, and the load, or sales charge, is pocketed by the broker and/or other middlemen as payment for the "service of helping you pick a  good fund."

You should be aware that there is no real difference historically between the performance of load funds and no-load funds in terms of year-to-year performance.   In fact, according to the latest survey by the mutual fund data analyzer Morningstar, even excluding the drag on returns if the load were included in the calculation, no-load funds actually have a superior record to load funds over the last 3-year and 5-year periods.

Let me repeat that for you!   Funds that impose no cost to purchase have outperformed those that brokers pay themselves to find for their clients.

Are you going to worry about the different types of load funds?   No!   You aren't going to buy one, so don't clutter your brain up with worthless facts!

The costs of owning a fund are called the expense ratio (This is distinct from the costs of buying a fund, which are the above said sales loads).   The expense ratio represents the percentage of the fund's assets that go purely toward the expense of running the fund.   The expense ratio covers the investment advisory fee, the administrative costs, 12b-1 distribution fees, and other operating expenses.   The nice thing about the expense ratio is that it wraps all these various costs and expenses into one number so that you don't have to do a lot of math.

To every fund, there is turnover, turnover, turnover.   And knowing the historical turnover of your fund choice is a necessary step to understanding the likely performance of a fund over time.   A fund's turnover rate basically represents the percentage of a fund's holdings that change every year.   "Turnover" is the gross proceeds from all sales divided by the total assets in the mutual fund.   In plainer English, turnover represents how much of a mutual fund's holdings are changed over the course of a year through buying and selling.   Managed mutual funds have an average turnover rate of approximately 85%, meaning that funds are turning over nearly all of their holdings every year.   Many funds, in fact, have turnover ratios of more than 100%, meaning their average holding period for a stock is less than one year.   With all of that turnover, who pays the taxes?   Hmmmmm, let's see... YOU DO!

The other principal category of actively managed mutual fund behavior that hurts shareholders is the cash reserves that make up such a large percentage of so many mutual funds.   For various reasons, actively managed mutual funds don't invest all the money at their disposal, but instead maintain cash balances of approximately 8%.   The annual rate of return on cash over the last 120 years or so has been about 4%.   The average annual return on stocks is around 11%.   Mutual fund managers are charging their shareholders an average of 1.5% a year on that 8% that they are keeping in cash.   That's cash that can't appreciate at the rate that stocks appreciate.   Wakeup, you're putting your money into mutual funds to own shares of stocks, not to pay somebody to own cash for you.