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Mutual funds are great investments but consider the sales charges and operating expenses that will reduce the return you earn on your investments. So do annual taxes, unless you invest in a tax-favored account like an employer's 401 (k) plan or an IRA.
Some funds charge loads - up front sales charges. If you invest $40,000, for example, in a fund with a 5% load, your actual amount invested is $38,000. To just break even in the first year, you would have to earn 5.3% ($2,000). Other funds charge back-end loads - a percentage or a flat fee deducted from a redemption. Still other funds charge level loads - a certain percentage deducted annually from fund assets. And some funds, known as no load funds, have no sales charges.
All mutual funds also have operating expenses - investment advisory fees and administrative costs. Many funds also charge a 12b-1 fee for marketing and distribution-related expenses.
You can learn more about the expenses of a fund by reviewing the prospectus. You should find a table illustrating the effect the fund's costs have had on returns over time.
Mutual funds distribute capital gains and interest/dividend income to their shareholders. Unless you invest through a tax-favored account, you are required to report the taxable distributions you receive on your return each year - even if you reinvest the money in additional fund shares. Paying taxes on fund distributions, in effect, reduces your return.
A fund's portfolio turnover rate measures the extent to which the fund sells securities and replaces them with new ones. The higher the rate, the more the activity. Choosing a fund with a lower turnover rate may reduce the capital gains reportable on your tax return during the time you own shares in the fund.
In 1998, due to the volitility of the market, many funds bought and sold many of their securities. This resulted in a lot of fees for the selling and purchasing of individual investment instuments. As a direct result of all these fees, many funds showed extensive losses.
Churning: This process of running up the fees to the point where all gains and dividends are wiped out is similar to "churning." Churning is a trick that unscrupulous brokers use to make money off their clients. Brokers who only get paid when a sale or purchase is executed through your account are motivated to earn their commissions by urging you to buy and sell your investments. This process is called "churning." Your account is constantly in a state of flux and the unscrupulous broker is getting wealthy on the commissions while you are growing broke.
If your broker is churning your account, get another broker immediately. Not all brokers are crooked, get an honest one. Make sure that the broker does not have the authority to buy or sell securities without your direct approval.
Get involved with your investments. If you cannot watch them, perhaps you need to own the stocks directly, without a broker, and invest in highly reliable investments.