Mutual Fund Trading Costs: The Most Important Fee You’ve Never Heard Of?
What if I told you that there is a fee present in mutual funds that is NOT included in the fund's published expense ratios and is often not publicly disclosed by the fund companies, since the SEC does not require its disclosure? You might laugh, but it is true. These added fees are known as trading costs.
Simply put, a mutual fund’s trading costs are the costs a fund incurs from buying and selling securities. In general, the more often a fund buys and sells securities, the greater its trading costs. Trading costs are NOT reported as part of the fund's expense ratio. And, since the SEC does not require disclosure, and commissions (a component of trading costs) are rarely disclosed in a fund’s prospectus, good luck trying to find these costs. The SEC does require that the dollar amount of commissions be reported, but this information is often relegated to a fund’s statement of additional information, a lengthy appendix to a fund prospectus that is only sometimes provided online. While some fund families translate the dollar amount of commissions into a percentage that can be added to the published expense ratio, others do not, making the investor do the math. Regardless of the level of disclosure, I doubt that the average investor will do the homework necessary to obtain this information.
How large is this expense? I have seen commissions range from less than a basis point (.01%) to over 1%. In fact, I have seen instances where the commissions (which, according to the Wall Street Journal article, "The Hidden Cost of Mutual Funds," published on March 1, 2010, account for less than half of total trading costs) actually exceeded the published expense ratio of the fund, essentially more than doubling the fund’s true cost! Such costs are higher for actively managed funds than for indexed funds, in particular for actively managed funds with high turnover rates of their portfolio of securities (which, unlike trading costs, IS required to be disclosed).
Why is this expense not disclosed? According to the Wall Street Journal (WSJ) article, the SEC has historically cited difficulty in quantifying non-commission elements of trading costs, such as bid-ask spreads, market impact costs, and opportunity costs as a rationale for not requiring disclosure. But, make no mistake, this fee is quite real, and, if sufficiently large, can be a major drag on investment returns (which, by the way, are reported NET of all expenses, including trading costs).
Surprisingly, little has been reported in the media about the existence of these mutual fund costs. The WSJ article I cite is from 2010, and a Google search reveals only a handful of articles on the subject published in the last decade.
Despite the lack of disclosure and publicity, plan sponsors need not be left in the dark about trading costs. Fund families can - and will - provide commission costs, and even estimates of total trading costs, to plan sponsors upon request.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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