Don't Ever Pay A Sales Charge For An S&P Index Fund
A core holding in many portfolios is an S&P 500 index fund. For Americans, it's the best known index, so it's often an easy purchase.
The S&P 500 captures about 80 percent of U.S. market capitalization; as such, it's a fairly good (though not perfect) gauge of domestic market performance.
But investors should use some caution when buying an S&P fund.
When buying a fund for your Individual Retirement Account (IRA), or a taxable brokerage account, you might opt for an inexpensive exchange-traded fund, such as the SPDR S&P 500 Trust (NYSE: SPY), which has an expense ratio of just 0.09 percent. Many investors gravitate toward index ETFs because of their low costs.
A Competitive Edge
But some mutual funds are priced competitively with ETFs. For example, the Schwab S&P 500 Index Fund (MUTF: SWPPX) also has an expense ratio of 0.09 percent.
Although an S&P index fund is among the most basic types of investments, not all products in the category are the same. In particular, some have high expense ratios, in addition to commissions paid to brokers who sell the funds to clients.
One egregious example of an expensive S&P index product is the MainStay S&P 500 Index Fund (MUTF: MSXAX). This fund comes with an astonishingly high maximum sales charge of 3 percent. That's on top of an already high expense ratio of 0.62 percent.
The expense ratio includes management and administrative fees, administrative fees, and various expenses related to fund operation. It also includes something called 12b-1 fees. These are fees that mutual fund companies pay to other firms that sell the funds. So if you buy certain funds through a large, national, brand-name brokerage, the fund manufacturer (which is what they are) is often passing that fee along to you, the buyer.
The problem with these charges is that they erode investor returns. Using 2013 as an example, it's easy to see how that can happen. That year, the S&P 500 had a total return, including dividends, of 32.39 percent.
The Package Deal
It's impossible to buy a pure index, however, so investors must turn to packaged products. All of these have some type of fee attached, to pay for managers' services. The Schwab S&P 500 Index Fund, mentioned above, returned 32.27 percent, net of fees.
The MainStay S&P 500 Index Fund returned 31.62 percent. Better than a kick in the teeth, but not so great, in comparison to cheaper S&P index funds.
If you're buying an S&P index fund as part of your 401(k), you probably don't have the option to select a cheaper fund. However, your 401(k) is almost certainly part of a large institutional platform, in which case the load is waived for many of the expensive products, such as the MainStay S&P 500 fund.
Incidentally, these high charges don't only apply to in-person brokers. People assume they are saving money by using online brokers, but that's not necessarily the case. There's no reason why an investor should ever buy a mutual fund with an upfront sales load. For every asset class that an investor hopes to access with a fund, there is always a no-load alternative. It's often not the one a brokerage firm is touting, however.
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