ROTH IRA Mutual Funds

[Guest BigAl]

First I want to thank many of you on this board, such as John G, Appleby and BPicker for such great advice. I have another question. My new ROTH's are with my American Express Financial Advisor, and their mutual fund family. I am pleased with my advisor, but seek your advise on AMEX mutual funds, as I am new to funds. They have Class A and B shares. "A" shares you pay a fee upon purchase, and "B" you pay when you sell. John G had mentioned no-loads with no fees. I thought all funds were either "A' or "B". Don't all funds require some kind of fee? Is American Express not offering the best in mutual funds? Any suggestions?

[papogi]

"No Load" mutual funds still charge you a fee. It is part of their annual expense percentage (typically, anywhere from .20% to 1.50%). Loaded funds have this annual fee as well, however. There is a long standing debate as to whether no-loads or loaded funds are better. The loaded funds say they give more complete advice and hire the best fund managers, and they say have to get the money somewhere to do that. Concerning their returns, I have seen a study which bears this out, but the difference is infinitesimal, and gets negated by the typically higher annual expenses. While I prefer and utilize only no-loads, the difference is very minor as long as you are leaving your money in there long enough to get past any surrender charge period. If you like your advisor, that's worth something. The most important thing is to invest wisely and for the long-term, and you seem to be doing that.

[John G]

Don't confuse loads and fund expenses and fees. Some folks use these terms very casually to mean any type of charges.

Fees normally refer to the annual charge for an IRA account. Not all funds have an annual charge, some that do waive the fee if the assets are above a specific level.

Loads are either an initial lump payment based upon a percent of the deposit or a back end percent charge against the total assets at exit. Loaded funds are primarily loaded because the commission is passed on to salespersons who have an incentive to "sell". No-load funds do not have a commissioned sales force, but rely on brochures, the internet and media coverage.

All funds have expenses. The funds with the lowest expenses are index funds where a computer makes stock purchases from a list, such as the S&P500, and there are no expenses for company visits and very low labor costs... the PC does all the work except customer service. On the high end you have high requirement funds such as country specific international funds.

Loaded funds especially punish anyone who decides to change custodians or funds (if not in the same family) after a few years. There are actually more classes of shares then just A and B for many loaded funds. But I will restrict my comments to front end vs back end loads. With front end load, you immediately skim off XX% of your funds and so your investment base is smaller. Back end loads do not reduce the initial base but are imposed on what should be a larger pool of assets. Back end loads were invented by the industry when they had trouble competing with no-load funds.

I am not very high on loaded funds, there are just too many underperformers on the marketplace being sold by the commissioned sales force. I would select a load type fund for only two reasons. First, if you are so unsure about investing that you want to leave all the decisions to a salesperson who will guide your choice. Problem with this is that the salesperson has a natural bias to steer you to the choice that gives them a good commission rather than one that gives you a good investment. Second, you have found a back-end loaded fund where the load is phased out after you assets have stayed with them for perhaps 6 or 8 years. Assuming that the underlying investment is performing well, this one of the better load type arrangements. The fund seeks to secure long term commitments and you in turn see the load slowly disappear. Ask AMX if that is what they offer.

No load vs loaded: since you have 8,000+ funds to choose from and you only need a couple of good ones, you can find reasonable choices from both domains... I prefer to do my own thinking and avoid the advice of salepersons, so I would be inclined to go the no load route.

Back to the issue of expenses: Do not assume that a loaded fund has no other annual expenses. They invariably do. Annual expenses have a very wide range. At the low end, some index funds get their annual expenses down below 0.30%. Actively managed funds based upon US stock market often will show annual expenses in the 0.75% to 1.50%. International funds, specialty funds (like environmental or social types), and sector funds (narrowly investing in a specific industry) tend to have annual expenses of 1.5 to 2.5%.

In the past twenty years, index funds have consistently beaten 80% or more of all actively managed funds. Why? Because they save 1% or more of the annual expenses. So a mindless computer picking stocks from a big list.... Vanguard 500 for example... tends to perform better than most teams that actively analyze stocks, interview CEOs and talk to vendors. It irritates anyone who believes in stock picking (which includes me) but it is just hard to overcome that 1% edge you give up. What this says is that stock picking is not nearly as big an issue as the asset (stocks, bonds, moneymarket, cd, or cash) allocation.

Yes, a handful of fund managers can put together a string of market beating performances. But, the common fund has a hard time consistently beating the performance of a ultra-low expense no load index fund.

[papogi]

Agreed. I also understand the difference between these various fees and expenses, and JohnG's explanation is very good. I was being too vague, but I just didn't want BigAl going away thinking that a no-load fund costs nothing to invest in. Even though their marketing expenses and expenses used for drumming up business will be far lower than a loaded fund utilizing a sales force, those expenses are still in there (truth be told, long ago I used to work for a company identified by a big rock as part of sales force JohnG describes). Even the no-load companies are in the business to make money. Believe me, I am a strong advocate of no-load funds as well, but BigAl, don't think that you just invested in Enron.

[mbozek]

There are more than just load charges and expenses to consider. The Vanguard S & P 500 fund charges about 17 basis points (.17%) v. about 100 bp for managed funds . However many funds also have charge hidden charges in the form of 12b-1 fees of between 25 and 100 bp for marketing expenses. Variable annuities have a mortality charge of between 100 and 125 bp. In some funds the total charges can exceed 200 -250 bp (2-2.5%) which is quite a drag on the return. This is why 75% of managed funds fail to beat the S & P in any one year. You need to read the section on expenses and fees in the prospectus to understand how much is being charged.

[John G]

The comment above on expenses is absolutely correct - they can be hidden in a number of spots including 12b.

Expenses above 2% is relatively rare and ussually related to exotic funds like niche international or a very specific focus fund. At least in those areas, there is some rationale basis for the expenses such as visiting companies around the world.

However, I have a hard time understanding the expense structure differences that may range form .5% to 1.8% for a set of similiar funds that are domestic large cap, especially when you can select an index domestic large cap with expenses below 0.3%.

We have probably dwelt too much time of fees, expenses and loads on mutual funds. Other issues to consider in selecting a fund: (1) who runs the fund and how long has he/she held the position, (2) the investment strategy or focus, (3) track record in up and down markets, (4) overall size - large funds are less nimble and more restricted in the firm in which they can invest (5) fund rules governing concentration, leverage, etc and (6) tax management or not {not an issue with IRAs just normal investing}. I am sure there are some other factors to consider.

I have no experience with AMEX associated funds. Perhaps others can comment on this specific family of funds.