What are not listed in the expense ratio are variable costs. The biggest variable costs are brokerage commissions and trading expenses. When­ever the fund manager buys or sells a security, he pays brokerage com­missions—just as you would if you were to buy or sell a stock or bond. Typically, funds spend tens of millions of dollars in trading costs per year, and these expenses are not included in the Annual Expense Ratio or even disclosed in the prospectus. To find these and other expenses, you must look in the fund’s Statement of Additional Information (SAI).

These additional expenses are difficult to determine, but a 2007 analysis by Virginia Tech, the University of Virginia and Boston Col­lege revealed that the average SAI charge is 1.44 percent per year. This is in addition to the 1.56 percent charged by the average Annual Expense Ratio. In other words, the total charge of the average mutual fund is 3.00 percent per year. If you pay an advisor 1 percent or more per year to manage your assets in what is known as a “wrap account,” you may be paying total annual costs that exceed 4 percent per year.  In this down market, the last thing you need is to be hit with layers and layers of fees!

4. All chips on the table all the time

Though I do not recommend market timing (trying to predict short-term stock market movements), I do believe it is prudent to be more cautious or defensive at times.  Most mutual funds stay 100% fully invested in the market at all times and do not account for changing economic conditions.  The charter of most equity mutual funds requires the fund manager to maintain high exposure to stocks indefinitely.   Whether there are good buys available or not, said manager has to keep buying companies knowing full well that the timing may not be right.  Worst yet, he may have only 20-25 stocks he feels have good upside yet his charter requires more diversification so he is forced to buy “losers” to spread out risk.

5.  One size fits all bad advice

Mutual funds get paid to keep you invested all the time.  Marketing materials can be sliced and diced to tell you the story you want to hear.   The fact of the matter remains that most mutual funds underperform their respective indices.  Good money managers are hard to find yet there are thousands of mutual funds lining up to handle your money.  

So where do you go?

It starts with find a team of financial professionals you can trust.  If you are a faith-based investor, a great place to start is seeking out a qualified Kingdom Advisor, who specializes in faith-based or biblically responsible investing.  There are many faith-based options that can support both your family’s goals and values.  Mutual funds aren’t the only game in town.  Stocks, bonds, ETFs, real estate, commodities, and gold offer additional choices to diversify your portfolio and help you have a better understanding of exactly what you own.

August 15, 2009

Jay Peroni, CFP® is a renowned financial advisor and author of The Faith-Based Millionaire (foreword by Dan Miller, author of 48 Days To the Work You Love) and The Faith-Based Investor, and is considered an expert authority on the subject of "Faith-Based Investing”. He is the founder of www.faithbasedinvestor.com, a faith-based investing newsletter and the founder of Values First Advisors, Inc. a firm dedicated to faith-based financial planning and money management.