November 9, 2009
The Right Way to Look At Entry Loads and Expenses
One of the factors that most investors tend to focus on while choosing a Mutual Fund is the percentage of entry loads and expenses. While no-load Mutual Funds appear attractive as you are promised full allocation of your funds, selecting one simply on that basis may not be the right thing to do.
No-load Mutual Funds mean that the entire amount invested by you is allocated for investment. A larger invested amount is obviously better but there is another side to it also.
When you invest in a Mutual Fund you are actually handing over your money to a portfolio manager who is an expert. There is hardly any need to remind you that there is never a free lunch: you have to pay for the services of the portfolio manager and the accompanying expenses of the asset management company.
While Mutual Fund fees and expenses are an important factor to consider, the ability of the portfolio manager to actively manage and rotate your funds is equally, if not more, important. If that was not the case then similar funds would give you similar returns. That however is never the case. Even index based funds tend to give widely different returns despite the focus on an almost similar basket of asset class.
Selecting a Mutual Fund simply on the basis of low or no entry load and low expense percentage is just like being penny wise and pound foolish.
The reality is that an asset management company is providing a service and there is a cost to it. Whatever way it is projected it is the end consumer who is going to pay for these irrespective of the fact whether you get good returns or not. The expenses of a Mutual Fund comprise of fixed and variable costs. The asset size of the Mutual Fund plays an important role because the fixed cost gets spread over a larger base, which will eventually reflect in a higher NAV.
The right approach is to focus on the expertise of the portfolio manager and a large asset base. Entry loads are important but secondary to these factors. It is always better to select a portfolio manager who places your interest before anything else and a fund that has the potential of deriving benefits from economy of scale and pass them on to its members.
If you are opting for a no-load Mutual Fund then it makes sense to focus on management expense ratios. Otherwise the right way to look at these is to understand the concept properly. It is not an absolute figure that is deducted from the returns you get. It is a sum that is taken off from the top. For example, if you invest amount X, then the amount that is invested in your account is X minus entry load. The percentage of entry load and expenses may vary between 1 to 3% depending upon the type of fund you invest it. Index based funds usually have lower entry fees as compared to high risk funds with more trading activity.
The right way of looking at entry loads is that you are actually paying for managing risks and safety of your capital.