WEBVTT 00:00:00.000 --> 00:00:01.860 Welcome back to the Deep Dive. So you've decided 00:00:01.860 --> 00:00:03.879 you want to start investing. You read all the 00:00:03.879 --> 00:00:05.940 headlines, right? Compounding interest, long 00:00:05.940 --> 00:00:07.799 term growth, the power of index funds. It sounds 00:00:07.799 --> 00:00:10.240 pretty simple. Buy low, hold for a few decades, 00:00:10.400 --> 00:00:12.880 retire comfortably. But then you get the prospectus 00:00:12.880 --> 00:00:16.480 and suddenly you're just drowning in jargon. 00:00:16.699 --> 00:00:21.379 CDSE, 12B1, expense ratios, breakpoints. It's 00:00:21.379 --> 00:00:23.920 like a hundred pages of acronyms and percentages 00:00:23.920 --> 00:00:26.910 that feels... It feels like it's designed to 00:00:26.910 --> 00:00:29.010 confuse you. It absolutely does. And that confusion, 00:00:29.210 --> 00:00:31.210 you know, that's exactly where the industry profits. 00:00:31.769 --> 00:00:34.310 Investing is, at its core, a simple concept. 00:00:34.670 --> 00:00:37.840 But mutual fund fees are anything but. Today, 00:00:37.960 --> 00:00:40.679 we're diving deep into those hidden costs, the 00:00:40.679 --> 00:00:42.520 charges that don't look like much on paper or 00:00:42.520 --> 00:00:45.320 maybe just a fraction of a percent, but they 00:00:45.320 --> 00:00:48.460 silently, relentlessly erode your long -term 00:00:48.460 --> 00:00:50.859 returns year after year. And we have dissected 00:00:50.859 --> 00:00:53.259 a phenomenal source document for this. It's like 00:00:53.259 --> 00:00:56.340 a genuine taxonomy of every single charge, fee, 00:00:56.500 --> 00:00:58.560 and expense a mutual fund investor could possibly 00:00:58.560 --> 00:01:00.479 encounter. It covers everything from that upfront 00:01:00.479 --> 00:01:03.299 sales commission to the operational friction 00:01:03.299 --> 00:01:07.519 deep inside the fund's trading desk. here for 00:01:07.519 --> 00:01:09.840 you is to not just read these definitions out 00:01:09.840 --> 00:01:12.939 loud. We want to truly map this financial landscape. 00:01:13.120 --> 00:01:16.060 We're building a clear, structured guide to all 00:01:16.060 --> 00:01:18.420 of these fees. By the time we finish this deep 00:01:18.420 --> 00:01:21.340 dive, you will understand the underlying purpose 00:01:21.340 --> 00:01:24.620 of every single charge. And that really is the 00:01:24.620 --> 00:01:27.920 only way to effectively compare funds and pick 00:01:27.920 --> 00:01:31.379 the best path for your capital. Okay, so let's 00:01:31.379 --> 00:01:33.700 frame the core problem right away. I mean, running 00:01:33.700 --> 00:01:36.540 a successful mutual fund. It's a complex business. 00:01:36.780 --> 00:01:39.180 They need top -tier investment talent, admin 00:01:39.180 --> 00:01:42.040 staff, legal, trading infrastructure, marketing. 00:01:42.180 --> 00:01:44.900 These are significant costs and, well, they have 00:01:44.900 --> 00:01:46.950 to be paid. Right. And they get passed directly 00:01:46.950 --> 00:01:49.989 to us, the investors, in two main buckets. First, 00:01:50.069 --> 00:01:52.689 you have the direct shareholder fees. These are 00:01:52.689 --> 00:01:54.590 charged when you buy or sell shares. And second, 00:01:54.670 --> 00:01:56.829 you have the indirect operating expenses. These 00:01:56.829 --> 00:01:58.709 are the percentage fees that are paid constantly 00:01:58.709 --> 00:02:01.250 right out of the fund's total assets. And that 00:02:01.250 --> 00:02:03.329 indirect stream of payments, that's the real 00:02:03.329 --> 00:02:05.170 focus, isn't it? Because that's the stealth killer 00:02:05.170 --> 00:02:07.989 of returns. It absolutely is. You know, we might 00:02:07.989 --> 00:02:10.210 look at a 1 .5 % annual fee and think, oh, it's 00:02:10.210 --> 00:02:13.610 only 1 .5%. But when you hold an investment for 00:02:13.610 --> 00:02:17.030 30 or 40 years, The compounding effect of that 00:02:17.030 --> 00:02:19.409 fee, just eating away at your potential gains 00:02:19.409 --> 00:02:22.650 year after year, it can reduce your final earnings 00:02:22.650 --> 00:02:25.689 by tens or even hundreds of thousands of dollars. 00:02:25.949 --> 00:02:28.210 This is why we always emphasize moving beyond 00:02:28.210 --> 00:02:30.490 the surface level claims and really calculating 00:02:30.490 --> 00:02:33.849 the total expense ratio or a TER. And then you 00:02:33.849 --> 00:02:36.930 have to compare it ruthlessly against the industry 00:02:36.930 --> 00:02:38.750 benchmarks. And when you look at those benchmarks, 00:02:38.949 --> 00:02:41.770 the initial data we pulled from 2020 on U .S. 00:02:41.770 --> 00:02:44.069 funds is incredibly stark. It just immediately 00:02:44.069 --> 00:02:46.750 highlights the economic credit. What are you 00:02:46.750 --> 00:02:48.930 actually getting for paying those extra percentage 00:02:48.930 --> 00:02:51.909 points? We have the weighted average total expense 00:02:51.909 --> 00:02:55.310 ratios for all U .S. funds as of December 31st, 00:02:55.310 --> 00:02:58.289 2020. And the difference between active and passive 00:02:58.289 --> 00:03:01.400 management. It's a profound knowledge nugget 00:03:01.400 --> 00:03:03.900 right out of the gate. Across all funds, the 00:03:03.900 --> 00:03:06.120 weighted average TER for all active funds was 00:03:06.120 --> 00:03:09.919 a staggering 1 .04%. Over 1%. Just for a human 00:03:09.919 --> 00:03:12.840 to try to beat the market? Exactly. Now, compare 00:03:12.840 --> 00:03:17.199 that to all passive or index funds. Their weighted 00:03:17.199 --> 00:03:22.620 average TER was a remarkably low 0 .45%. That's 00:03:22.620 --> 00:03:24.960 a cost difference of nearly 60 basis points right 00:03:24.960 --> 00:03:26.719 away. Wait, I have to challenge that just for 00:03:26.719 --> 00:03:28.819 a second. An active management advocate would 00:03:28.819 --> 00:03:32.460 say, well, that 1 .04 % fee is totally justified 00:03:32.460 --> 00:03:34.879 if my manager delivers an extra 2 % return, you 00:03:34.879 --> 00:03:38.120 know, netting me 10 % instead of 8%. Do investors 00:03:38.120 --> 00:03:41.080 actually tolerate this huge gap? We do. They 00:03:41.080 --> 00:03:43.539 tolerate it based on hope. And on the historical 00:03:43.539 --> 00:03:46.539 reality that while most active managers do underperform, 00:03:46.759 --> 00:03:49.080 the possibility that you'll pick that one outlier 00:03:49.080 --> 00:03:51.620 who consistently wins, well, that's enough to 00:03:51.620 --> 00:03:54.009 keep the money flowing. But the trend is clear. 00:03:54.169 --> 00:03:56.569 The market is moving toward passive, largely 00:03:56.569 --> 00:03:58.610 because of data like this. And look at specific 00:03:58.610 --> 00:04:00.509 asset classes where the margin is even thinner. 00:04:00.860 --> 00:04:04.819 Taxable bond funds. Active averaged 0 .85 % versus 00:04:04.819 --> 00:04:08.919 passive at a breathtakingly low 0 .23%. In a 00:04:08.919 --> 00:04:11.319 low return world like fixed income, paying that 00:04:11.319 --> 00:04:13.180 extra fee means you're consuming a much, much 00:04:13.180 --> 00:04:15.479 larger chunk of your gross return. That data 00:04:15.479 --> 00:04:18.120 right there confirms that chasing low costs isn't 00:04:18.120 --> 00:04:21.100 just about saving a few bucks. It's about maximizing 00:04:21.100 --> 00:04:24.029 the efficiency of your capital. Okay, let's unpack 00:04:24.029 --> 00:04:26.389 the specifics then. We'll start with the upfront, 00:04:26.529 --> 00:04:29.089 direct charges. The fees that are levied directly 00:04:29.089 --> 00:04:32.310 against you when you move money in or out. These 00:04:32.310 --> 00:04:34.509 are the transactional fees paid to the fund. 00:04:34.689 --> 00:04:36.870 Right. Think of these as the administrative costs, 00:04:37.009 --> 00:04:38.810 and they're distinct from sales commissions. 00:04:39.050 --> 00:04:40.790 They're like the toll booths you hit on the investment 00:04:40.790 --> 00:04:43.089 highway. First up, we have the purchase fee, 00:04:43.250 --> 00:04:46.350 charged when you buy shares. Why is the distinction 00:04:46.350 --> 00:04:49.449 between this and a front -end sales load so important? 00:04:49.949 --> 00:04:51.970 That distinction is critical, and it really goes 00:04:51.970 --> 00:04:54.689 to the regulatory framework. A front -end load, 00:04:54.850 --> 00:04:57.170 which we'll get to, is a commission paid to the 00:04:57.170 --> 00:04:59.810 broker who sold you the fund. A purchase fee 00:04:59.810 --> 00:05:02.509 is paid directly to the fund itself. Its purpose 00:05:02.509 --> 00:05:05.410 is purely administrative. It's there to defray 00:05:05.410 --> 00:05:07.850 the fund's internal costs associated with your 00:05:07.850 --> 00:05:10.800 purchase. It's not for sales advice. So if I 00:05:10.800 --> 00:05:14.480 put $10 ,000 into a fund, a 1 % purchase fee 00:05:14.480 --> 00:05:17.519 means the fund keeps $100 to cover paperwork, 00:05:17.779 --> 00:05:20.459 whereas a 1 % front -end load means the broker 00:05:20.459 --> 00:05:23.579 keeps $100 for selling it to me. Precisely. The 00:05:23.579 --> 00:05:25.759 purchase fee is about the mechanical cost of 00:05:25.759 --> 00:05:29.000 integrating your money. And conceptually, it 00:05:29.000 --> 00:05:31.540 can also act as a sort of minor protection for 00:05:31.540 --> 00:05:34.139 existing shareholders. It ensures that new money 00:05:34.139 --> 00:05:36.540 coming in pays its own way and doesn't dilute 00:05:36.540 --> 00:05:38.160 the interests of people already holding shares. 00:05:38.480 --> 00:05:40.449 Then we have the mirror image. The redemption 00:05:40.449 --> 00:05:42.970 fee. This is charged when you sell or redeem 00:05:42.970 --> 00:05:46.269 shares. And this is a fee paid directly to the 00:05:46.269 --> 00:05:48.610 fund when you pull your money out. Again, this 00:05:48.610 --> 00:05:50.310 is not the broker's commission. That would be 00:05:50.310 --> 00:05:53.170 a deferred sales load. The redemption fee is 00:05:53.170 --> 00:05:55.810 designed to defray the fund's costs associated 00:05:55.810 --> 00:05:58.750 with liquidating assets to meet your redemption 00:05:58.750 --> 00:06:01.029 request. But the redemption fee often serves 00:06:01.029 --> 00:06:03.569 a second, maybe unstated purpose, doesn't it? 00:06:03.670 --> 00:06:06.430 Absolutely. It's a mechanism to deter short -term 00:06:06.430 --> 00:06:08.829 trading. If an investor is constantly buying 00:06:08.829 --> 00:06:10.949 and selling, you know, trying to time the market, 00:06:11.089 --> 00:06:13.610 that activity can force the fund manager to make 00:06:13.610 --> 00:06:16.990 unnecessary trades. And that raises costs and 00:06:16.990 --> 00:06:19.069 disrupts the strategy for all the long -term 00:06:19.069 --> 00:06:22.360 holders. So by imposing a redemption fee... especially 00:06:22.360 --> 00:06:25.860 one that expires after, say, 60 days, the fund 00:06:25.860 --> 00:06:28.660 discourages that disruptive behavior. That suddenly 00:06:28.660 --> 00:06:32.199 makes the fee seem beneficial rather than punitive 00:06:32.199 --> 00:06:34.360 if you're a long -term holder. It's all about 00:06:34.360 --> 00:06:36.579 aligning interests. Okay, finally, in this category, 00:06:36.600 --> 00:06:39.740 we have the very specific exchange fee. Right. 00:06:39.800 --> 00:06:42.040 This is a fee you pay if you transfer shares 00:06:42.040 --> 00:06:44.660 to another fund within the same family of funds. 00:06:45.550 --> 00:06:48.110 So let's say you hold the Sterling Large Cap 00:06:48.110 --> 00:06:50.550 Growth Fund and you decide you want to move that 00:06:50.550 --> 00:06:52.470 capital to the Sterling International Bond Fund. 00:06:52.689 --> 00:06:54.509 You're staying with the same company, but you're 00:06:54.509 --> 00:06:56.529 making them process a full sale and a full purchase 00:06:56.529 --> 00:06:58.610 internally. Is that really always necessary? 00:06:58.889 --> 00:07:01.029 I mean, they already have my money. Why the extra 00:07:01.029 --> 00:07:03.769 charge? It's a processing fee. The complexity 00:07:03.769 --> 00:07:06.029 of transferring assets, updating shareholder 00:07:06.029 --> 00:07:09.149 records, and potentially liquidating assets in 00:07:09.149 --> 00:07:10.949 the first fund and acquiring them in the second. 00:07:11.449 --> 00:07:13.689 It just warrants a small administrative charge. 00:07:14.170 --> 00:07:16.370 It's their way of recouping the labor involved. 00:07:16.509 --> 00:07:19.290 So purchase, redemption, and exchange fees. That's 00:07:19.290 --> 00:07:22.389 our first bucket. Transactional costs paid directly 00:07:22.389 --> 00:07:24.769 to the fund for the mechanics of moving money. 00:07:24.889 --> 00:07:27.790 Exactly. One -time hits for specific actions. 00:07:28.029 --> 00:07:30.629 So that covers the one -time hit. But what about 00:07:30.629 --> 00:07:33.009 what happens every single day the fund is operating? 00:07:33.509 --> 00:07:37.029 The engine still needs fuel, maintenance, marketing. 00:07:37.129 --> 00:07:40.189 If those direct fees are the toll booths, these 00:07:40.189 --> 00:07:42.709 periodic operating expenses are like the fund's 00:07:42.709 --> 00:07:45.360 ongoing utility. bill. It's paid constantly, 00:07:45.540 --> 00:07:47.899 automatically from the fund's assets. This is 00:07:47.899 --> 00:07:50.339 that persistent, invisible draw on your capital. 00:07:50.680 --> 00:07:53.560 So what exactly are these ongoing costs covering 00:07:53.560 --> 00:07:57.620 that justifies paying them 365 days a year? Well, 00:07:57.639 --> 00:07:59.459 we start with the most essential and usually 00:07:59.459 --> 00:08:02.379 the largest component, the management fee. The 00:08:02.379 --> 00:08:05.899 heavyweight champion. Indeed. This fee is paid 00:08:05.899 --> 00:08:08.680 out of the fund's assets to the fund's investment 00:08:08.680 --> 00:08:11.579 advisor. This is a big one because it covers 00:08:11.579 --> 00:08:15.100 the core function. portfolio management, the 00:08:15.100 --> 00:08:17.839 salaries for it, for the fund manager, the research 00:08:17.839 --> 00:08:21.800 analysts, the strategists, the team doing the 00:08:21.800 --> 00:08:24.759 intense work of picking stocks and bonds. And 00:08:24.759 --> 00:08:26.720 it's not just the investment decisions, is it? 00:08:26.779 --> 00:08:29.259 Correct. The management fee often bundles in 00:08:29.259 --> 00:08:31.379 other general management or administrative fees. 00:08:32.039 --> 00:08:34.159 Our source notes, they're also sometimes called 00:08:34.159 --> 00:08:36.639 maintenance fees. It's sort of a catch -all for 00:08:36.639 --> 00:08:38.379 the intellectual property and the administrative 00:08:38.379 --> 00:08:40.740 oversight that the advisory firm provides. And 00:08:40.740 --> 00:08:43.899 if a fund is huge, say $10 billion in assets 00:08:43.899 --> 00:08:46.779 under management, and it charges a 1 % management 00:08:46.779 --> 00:08:49.899 fee? That's $100 million in fees a year. That 00:08:49.899 --> 00:08:52.220 is a substantial piece of business. It shows 00:08:52.220 --> 00:08:54.399 you the scale, and that management fee is the 00:08:54.399 --> 00:08:56.379 primary reason for the price difference between 00:08:56.379 --> 00:08:59.159 active and passive funds. Passive funds don't 00:08:59.159 --> 00:09:01.379 need a team of expensive analysts trying to beat 00:09:01.379 --> 00:09:04.019 the S &P 500. They just need algorithms to replicate 00:09:04.019 --> 00:09:06.899 it. Okay, moving on. We have the specific account 00:09:06.899 --> 00:09:08.620 fee. This is separately imposed on investors 00:09:08.620 --> 00:09:10.830 for account maintenance. And this is a point 00:09:10.830 --> 00:09:13.789 of concern for new or smaller investors. The 00:09:13.789 --> 00:09:16.049 source material really emphasizes that some funds 00:09:16.049 --> 00:09:18.889 impose this fee specifically on accounts whose 00:09:18.889 --> 00:09:21.350 value is less than a certain dollar amount. That 00:09:21.350 --> 00:09:24.009 seems counterproductive. You're penalizing the 00:09:24.009 --> 00:09:26.570 exact people you want to encourage to start saving. 00:09:26.710 --> 00:09:29.789 It's purely economic for the fund. If they figure 00:09:29.789 --> 00:09:31.490 that the administrative cost of maintaining, 00:09:31.690 --> 00:09:35.070 say, a sub $2 ,000 account is disproportionately 00:09:35.070 --> 00:09:37.669 high relative to the tiny management fee they 00:09:37.669 --> 00:09:40.289 collect on it, they impose this account fee to 00:09:40.289 --> 00:09:42.649 cover their overhead. So if your balance dips 00:09:42.649 --> 00:09:45.149 below their threshold, you get hit with a specific 00:09:45.149 --> 00:09:47.789 annual charge just for holding a small balance. 00:09:48.029 --> 00:09:50.309 Now let's move to one of the most famous and, 00:09:50.389 --> 00:09:53.450 frankly, historically controversial fees, distribution 00:09:53.450 --> 00:09:56.669 and service fees, known everywhere as the 12b 00:09:56.669 --> 00:10:00.110 -1 rule. Named after Section 12 of the Investment 00:10:00.110 --> 00:10:03.340 Company Act of 1940. This fee is basically the 00:10:03.340 --> 00:10:05.639 fund's marketing budget, and it's paid for by 00:10:05.639 --> 00:10:08.179 your investment dollars. These fees are explicitly 00:10:08.179 --> 00:10:11.740 paid by the fund, out -of -fund assets, to cover 00:10:11.740 --> 00:10:14.299 the costs of marketing, selling shares, and providing 00:10:14.299 --> 00:10:16.460 shareholder services. Let's break down those 00:10:16.460 --> 00:10:19.179 two components, distribution versus service. 00:10:19.519 --> 00:10:21.860 So distribution fees are the costs of bringing 00:10:21.860 --> 00:10:24.519 in new money. This is the compensation for brokers 00:10:24.519 --> 00:10:26.600 and financial intermediaries who sell the fund 00:10:26.600 --> 00:10:29.799 shares. It covers advertising, printing, and 00:10:29.799 --> 00:10:33.000 mailing prospectuses to new investors. All the 00:10:33.000 --> 00:10:35.240 sales literature. It's the cost of growth. And 00:10:35.240 --> 00:10:37.399 the shareholder service fees part. That covers 00:10:37.399 --> 00:10:39.779 the ongoing support. The people who answer investor 00:10:39.779 --> 00:10:42.159 questions, handle address changes, and provide 00:10:42.159 --> 00:10:44.620 information. This is the cost of maintaining 00:10:44.620 --> 00:10:47.039 the relationship. And a crucial point from the 00:10:47.039 --> 00:10:49.940 source. These servicing fees can be paid either 00:10:49.940 --> 00:10:53.490 inside or outside of a Rule 12b -1 plan. meaning 00:10:53.490 --> 00:10:55.850 they might be hidden in that other expenses bucket. 00:10:56.090 --> 00:10:58.909 And here it is, the classic aha moment that trips 00:10:58.909 --> 00:11:01.649 up every new investor, the no -load loophole. 00:11:01.929 --> 00:11:04.990 How can a fund that charges a 12B1 fee still 00:11:04.990 --> 00:11:07.649 call itself no -load? It's a regulatory definition 00:11:07.649 --> 00:11:11.250 game. The term load strictly refers to the sales 00:11:11.250 --> 00:11:13.850 commission paid to the broker. Funds can charge 00:11:13.850 --> 00:11:18.049 up to 0 .25 % of fund assets annually in these 00:11:18.049 --> 00:11:20.669 distribution fees and still legally describe 00:11:20.669 --> 00:11:24.610 themselves as no -load. That 25 basis points 00:11:24.610 --> 00:11:27.190 is a persistent annual fee for distribution. 00:11:27.710 --> 00:11:31.649 Yet the fund gets to advertise zero upfront sales 00:11:31.649 --> 00:11:35.429 cost. So on $10 ,000, that's 25 bucks a year. 00:11:35.549 --> 00:11:38.009 It doesn't sound like much. But over 30 years, 00:11:38.029 --> 00:11:41.049 that $25 compounding annually is not trivial. 00:11:41.250 --> 00:11:44.129 And it confirms that no load is a marketing term. 00:11:44.230 --> 00:11:46.610 It's not a statement of zero cost. It's a statement 00:11:46.610 --> 00:11:49.440 of zero sales commission. The fund is still paying 00:11:49.440 --> 00:11:51.519 for marketing, and you're paying for it through 00:11:51.519 --> 00:11:53.860 a continuous small percentage reduction in your 00:11:53.860 --> 00:11:55.899 capital. It's a critical distinction. And that 00:11:55.899 --> 00:11:58.399 moves us to the really shadowy category in operating 00:11:58.399 --> 00:12:00.679 expenses, other operating expenses, specifically 00:12:00.679 --> 00:12:03.419 the transaction costs. This is where it gets 00:12:03.419 --> 00:12:05.980 really interesting, because this cost is invisible 00:12:05.980 --> 00:12:08.919 to the casual investor. Yet it's often a significant 00:12:08.919 --> 00:12:11.480 drag on performance, especially for actively 00:12:11.480 --> 00:12:15.220 managed funds. Transaction costs are the actual 00:12:15.220 --> 00:12:18.039 expenses the fund incurs when it buys and sells 00:12:18.039 --> 00:12:20.659 its underlying assets. So brokerage commissions, 00:12:21.100 --> 00:12:24.799 exchange fees, bid -ask spreads, settlement costs. 00:12:25.139 --> 00:12:28.159 Why do these costs vary so much between different 00:12:28.159 --> 00:12:31.440 funds? They're driven by two key internal decisions. 00:12:31.860 --> 00:12:35.259 First, the fund's turnover ratio. This measures 00:12:35.259 --> 00:12:37.320 how frequently a fund replaces its holdings. 00:12:37.440 --> 00:12:40.360 A 100 % turnover ratio means the manager, on 00:12:40.360 --> 00:12:42.500 average, sold and replaced the entire portfolio 00:12:42.500 --> 00:12:45.480 over the year. High turnover funds generate massive 00:12:45.480 --> 00:12:47.500 trading friction. What's considered a high turnover? 00:12:48.100 --> 00:12:50.299 Generally, anything over 100 % is very high. 00:12:50.500 --> 00:12:52.480 Index funds, by contrast, might have turnover 00:12:52.480 --> 00:12:55.240 ratios well below 10%. The difference is just 00:12:55.240 --> 00:12:57.720 night and day. And the second factor? The type 00:12:57.720 --> 00:13:00.600 of market the fund trades in. If a fund is investing 00:13:00.600 --> 00:13:03.289 in highly liquid major market stocks like the 00:13:03.289 --> 00:13:06.529 S &P 500, transaction costs are low. But if they're 00:13:06.529 --> 00:13:09.990 investing in illiquid, emerging or exotic markets, 00:13:10.009 --> 00:13:12.950 say small cap stocks in Vietnam, the cost of 00:13:12.950 --> 00:13:15.389 entry and exit will be significantly higher. 00:13:15.850 --> 00:13:18.370 Okay, here's the core technical nugget that everyone 00:13:18.370 --> 00:13:20.789 needs to remember. Unlike the management fee 00:13:20.789 --> 00:13:23.590 or the 12B1 fee, which are all rolled up into 00:13:23.590 --> 00:13:26.350 the total expense ratio, these transaction costs 00:13:26.350 --> 00:13:28.889 are usually not reported directly to the investor. 00:13:29.090 --> 00:13:31.769 Correct. This is a regulatory loophole that frustrates 00:13:31.769 --> 00:13:34.850 a lot of industry analysts. The TR captures advisory, 00:13:35.230 --> 00:13:38.029 admin, and distribution costs. But the trading 00:13:38.029 --> 00:13:40.019 friction... the cost of moving assets around. 00:13:40.240 --> 00:13:42.279 It's not required to be itemized and reported. 00:13:42.519 --> 00:13:44.980 Instead, that cost is just absorbed by the fund 00:13:44.980 --> 00:13:47.320 and reflected in a slightly lower net asset value, 00:13:47.480 --> 00:13:50.259 or NAV, every single day. It's an invisible tax 00:13:50.259 --> 00:13:52.159 on performance. How can we estimate it? Give 00:13:52.159 --> 00:13:54.500 us a hypothetical. So if you invest $10 ,000 00:13:54.500 --> 00:13:58.159 in an actively managed fund with a 100 % turnover 00:13:58.159 --> 00:14:01.879 ratio, you might implicitly incur an extra half 00:14:01.879 --> 00:14:04.759 a percent, maybe 1%, in hidden transaction costs 00:14:04.759 --> 00:14:08.110 every year. That half a percent, 50 bucks a year 00:14:08.110 --> 00:14:10.769 on 10 grand, is a cost you never see itemized. 00:14:11.289 --> 00:14:13.929 But it's paid. So if I'm comparing two active 00:14:13.929 --> 00:14:18.289 funds, fund A has a T of 1 % with 10 % turnover. 00:14:18.509 --> 00:14:21.809 Fund B has a tier of 1 % with 150 % turnover. 00:14:22.090 --> 00:14:24.509 I should mentally realize that fund B's true 00:14:24.509 --> 00:14:28.269 cost is probably closer to 1 .5 or 2%. Absolutely. 00:14:28.789 --> 00:14:31.710 High turnover in an active fund is a massive 00:14:31.710 --> 00:14:35.029 red flag that demands a deeper look. Okay. We've 00:14:35.029 --> 00:14:37.690 covered fees paid to the fund and fees paid from 00:14:37.690 --> 00:14:40.309 the fund's assets. Now we get to the third big 00:14:40.309 --> 00:14:42.649 bucket, the loads. This is where the money goes 00:14:42.649 --> 00:14:44.350 to the intermediary. It's the sales commission. 00:14:44.669 --> 00:14:46.190 This is the commission structure that really 00:14:46.190 --> 00:14:48.950 defines the different share classes, A, B, and 00:14:48.950 --> 00:14:51.629 C. A sales load is a percentage charge on the 00:14:51.629 --> 00:14:53.830 purchase or sale of shares. It's the commission 00:14:53.830 --> 00:14:55.789 paid to the broker who puts you into the fund. 00:14:56.009 --> 00:14:57.669 Let's start with the most traditional structure, 00:14:57.990 --> 00:15:01.269 the front -end load, which is the hallmark of 00:15:01.269 --> 00:15:03.789 Class A shares. This is also known as a sales 00:15:03.789 --> 00:15:06.370 charge. It's a fee paid right when you purchase 00:15:06.370 --> 00:15:09.049 the shares. And as we established, it goes straight 00:15:09.049 --> 00:15:12.450 to the brokers. The key impact on your investment 00:15:12.450 --> 00:15:15.909 is immediate and substantial. It's not just a 00:15:15.909 --> 00:15:18.590 charge. It reduces your starting capital. Exactly. 00:15:18.610 --> 00:15:20.870 Let's use that classic example. You bring $10 00:15:20.870 --> 00:15:24.370 ,000 to invest in a fund with a 5 % front -end 00:15:24.370 --> 00:15:27.870 load. The brokerage firm immediately takes $500 00:15:27.870 --> 00:15:32.120 as their commission. Only $9 ,500 is actually 00:15:32.120 --> 00:15:35.139 invested in the market. So that $9 ,500 has to 00:15:35.139 --> 00:15:37.940 gain over 5 % just to get you back to your starting 00:15:37.940 --> 00:15:40.379 $10 ,000. You start the race behind the starting 00:15:40.379 --> 00:15:42.480 line. That's the psychological friction. Your 00:15:42.480 --> 00:15:45.000 money is immediately playing catch up just to 00:15:45.000 --> 00:15:48.009 break even on the commission. The one advantage, 00:15:48.129 --> 00:15:50.429 though, is that once you pay that upfront load, 00:15:50.629 --> 00:15:53.570 the annual operating expenses for Class A shares, 00:15:53.750 --> 00:15:56.990 including the 12B1 fees, tend to be the lowest 00:15:56.990 --> 00:15:59.169 of all the share classes. And there are legal 00:15:59.169 --> 00:16:01.850 limits on this initial hit, right? Yes, though 00:16:01.850 --> 00:16:04.570 they are rarely tested these days. Under the 00:16:04.570 --> 00:16:08.029 Investment Company Act of 1940, the max is 9%. 00:16:08.029 --> 00:16:12.570 Under fine IRA rules, it's capped at 8 .5%. High 00:16:12.570 --> 00:16:15.220 numbers, but they set the legal boundary. All 00:16:15.220 --> 00:16:17.340 right, moving on to the back -end load, which 00:16:17.340 --> 00:16:19.440 is typically associated with Class B shares. 00:16:19.899 --> 00:16:22.340 This one is known as a contingent deferred sales 00:16:22.340 --> 00:16:26.500 charge, or CDSC. As the name says, it's a fee 00:16:26.500 --> 00:16:29.200 paid when shares are sold, hence batch -end. 00:16:29.779 --> 00:16:32.059 It still typically goes to the stockbrokers who 00:16:32.059 --> 00:16:34.940 sold the fund. Why would a broker agree to defer 00:16:34.940 --> 00:16:37.399 their commission? Because the fund compensates 00:16:37.399 --> 00:16:39.860 them up front anyway. It advances the commission, 00:16:40.019 --> 00:16:42.620 then collects it over time through higher annual 00:16:42.620 --> 00:16:45.649 12B1 fees from the investor. Backed by the promise 00:16:45.649 --> 00:16:48.009 of that CDSC if the investor leaves early, the 00:16:48.009 --> 00:16:49.809 whole structure is designed for long -term retention. 00:16:50.210 --> 00:16:52.690 So if I buy Class B shares, I pay no upfront 00:16:52.690 --> 00:16:54.830 commission, but I'm implicitly locked into a 00:16:54.830 --> 00:16:56.870 holding period. Think of it like a free cell 00:16:56.870 --> 00:16:58.750 phone deal where you're locked into a seven -year 00:16:58.750 --> 00:17:01.409 service contract with a huge early termination 00:17:01.409 --> 00:17:05.650 fee. The CDSC starts high, often 5 % or 6 % in 00:17:05.650 --> 00:17:08.809 the first year. But here's the key feature. The 00:17:08.809 --> 00:17:11.430 fee incrementally discounts for each year you 00:17:11.430 --> 00:17:14.420 hold the shares. After maybe five, six, or seven 00:17:14.420 --> 00:17:17.579 years, the fee usually decreases to zero. And 00:17:17.579 --> 00:17:19.700 that schedule has to be clearly disclosed in 00:17:19.700 --> 00:17:22.119 the prospectus. So if I sell in year one, I pay 00:17:22.119 --> 00:17:25.259 the full 6%. If I sell in year eight, I pay nothing. 00:17:25.519 --> 00:17:28.759 It's a stick to keep you invested. Exactly. It 00:17:28.759 --> 00:17:31.259 smooths the compensation for the broker and protects 00:17:31.259 --> 00:17:33.839 the fund from having to liquidate assets prematurely. 00:17:33.940 --> 00:17:37.339 Okay. Next, the hybrid. The level load or low 00:17:37.339 --> 00:17:39.599 load. This is sometimes associated with Class 00:17:39.599 --> 00:17:42.240 C shares, but it's a bit different. Like back 00:17:42.240 --> 00:17:45.000 -end loads, no charge is paid when buying. If 00:17:45.000 --> 00:17:47.180 a back -end load is charged when you sell, the 00:17:47.180 --> 00:17:49.279 time frame is significantly shorter than a standard 00:17:49.279 --> 00:17:51.859 CDSC, maybe just one or two years. It's less 00:17:51.859 --> 00:17:53.460 of a seven -year commitment and more of a short 00:17:53.460 --> 00:17:55.680 -term deterrent. And finally, the structure that 00:17:55.680 --> 00:17:57.759 causes the most confusion because of marketing, 00:17:57.960 --> 00:18:01.220 the no -load fund. Associated primarily with 00:18:01.220 --> 00:18:04.640 Class C shares. A no -load fund does not charge 00:18:04.640 --> 00:18:07.240 any type of sales load. No upfront commission, 00:18:07.400 --> 00:18:10.299 maybe a very small short -term back -end charge, 00:18:10.460 --> 00:18:13.140 or none at all. But this is the big aha moment 00:18:13.140 --> 00:18:15.880 we need to really drive home. Not every fee is 00:18:15.880 --> 00:18:18.319 a sales load. So what's the tradeoff for zero 00:18:18.319 --> 00:18:20.500 commission? The tradeoff is simple. High annual 00:18:20.500 --> 00:18:23.400 fees. While a no -load fund can still charge 00:18:23.400 --> 00:18:25.680 those administrative transaction fees, purchase, 00:18:25.819 --> 00:18:28.519 redemption, exchange, the core issue is that 00:18:28.519 --> 00:18:30.859 Class C shares generally have the highest annual 00:18:30.859 --> 00:18:34.299 expense charges of all share classes. The ongoing 00:18:34.299 --> 00:18:37.720 12B1 fee and other administrative expenses are 00:18:37.720 --> 00:18:39.940 structured higher to perpetually compensate the 00:18:39.940 --> 00:18:42.420 brokers who sold them. So Class A hits you hard 00:18:42.420 --> 00:18:45.230 once but runs cheaply forever. Class C lets you 00:18:45.230 --> 00:18:47.289 in for free, but charges you a little bit every 00:18:47.289 --> 00:18:50.089 single day. Precisely. If you are a short -term 00:18:50.089 --> 00:18:52.509 investor, Class C might look attractive. But 00:18:52.509 --> 00:18:54.329 for someone holding the fund for 10 or more years, 00:18:54.509 --> 00:18:56.690 the cumulative cost of that higher annual expense 00:18:56.690 --> 00:18:59.349 ratio in Class C will almost certainly exceed 00:18:59.349 --> 00:19:01.029 the initial load you would have paid on Class 00:19:01.029 --> 00:19:03.730 A shares. The cost doesn't vanish. It just changes 00:19:03.730 --> 00:19:06.329 form. That is a critical piece of synthesis. 00:19:06.789 --> 00:19:09.269 The cost doesn't vanish. It just changes form. 00:19:09.490 --> 00:19:12.630 Changes the psychology, but the economics are 00:19:12.630 --> 00:19:16.309 relentless. Okay, now let's shift gears. We've 00:19:16.309 --> 00:19:19.089 defined the taxonomy. Now we connect this to 00:19:19.089 --> 00:19:21.329 the bigger picture, looking at the regulatory 00:19:21.329 --> 00:19:23.950 and structural details unique to the U .S. market. 00:19:24.509 --> 00:19:27.170 Let's start by drilling down on Class A shares 00:19:27.170 --> 00:19:30.029 and the volume discounts available, breakpoints. 00:19:30.549 --> 00:19:33.170 Breakpoints are essentially volume discounts 00:19:33.170 --> 00:19:36.500 for fund investors. Funds that charge front -end 00:19:36.500 --> 00:19:39.400 sales loads often charge lower loads for larger 00:19:39.400 --> 00:19:42.200 investments. These predefined investment levels 00:19:42.200 --> 00:19:44.299 are called breakpoints. It sounds like buying 00:19:44.299 --> 00:19:46.839 in bulk. Why is this so significant? It drastically 00:19:46.839 --> 00:19:49.240 changes the economics of the investment. For 00:19:49.240 --> 00:19:51.640 instance, a fund might charge a 5 % load on investments 00:19:51.640 --> 00:19:55.299 under $25 ,000, but only 4 % if you invest between 00:19:55.299 --> 00:19:58.460 $25 ,000 and $50 ,000. Recognizing and hitting 00:19:58.460 --> 00:20:00.900 those breakpoints saves you a huge chunk of capital 00:20:00.900 --> 00:20:03.440 right at the start. Is the fund required to offer 00:20:03.440 --> 00:20:07.619 these? No. The SEC doesn't mandate that a fund 00:20:07.619 --> 00:20:11.579 offer breakpoints. But the crucial rule is, if 00:20:11.579 --> 00:20:14.859 they do exist, the fund must fully and clearly 00:20:14.859 --> 00:20:17.869 disclose them. The onus is on the investor to 00:20:17.869 --> 00:20:19.990 know they exist. And there's a major ethical 00:20:19.990 --> 00:20:21.930 responsibility tied to the broker here, right? 00:20:22.190 --> 00:20:25.730 Absolutely. Fenner is very clear on this. Brokerage 00:20:25.730 --> 00:20:27.990 firms must not sell shares in an amount that 00:20:27.990 --> 00:20:30.849 is just below a breakpoint simply to earn a higher 00:20:30.849 --> 00:20:32.670 commission. It's called a breakpoint violation. 00:20:33.049 --> 00:20:35.849 It's a breach of fiduciary duty. So how does 00:20:35.849 --> 00:20:38.230 an investor who might not have $50 ,000 all at 00:20:38.230 --> 00:20:40.349 once make sure they qualify for the lowest possible 00:20:40.349 --> 00:20:43.559 load? This is the actionable takeaway. This is 00:20:43.559 --> 00:20:45.599 where we get into some advanced strategies, which 00:20:45.599 --> 00:20:47.920 should be in every prospectus. There are two 00:20:47.920 --> 00:20:50.220 main ways funds help you aggregate your investments 00:20:50.220 --> 00:20:53.160 to hit breakpoints. Rights of accumulation, or 00:20:53.160 --> 00:20:56.839 ROA, and letters of intent, or LOI. Explain rights 00:20:56.839 --> 00:21:00.000 of accumulation. ROA means that the fund counts 00:21:00.000 --> 00:21:02.299 the total value of all investments you currently 00:21:02.299 --> 00:21:05.059 hold with that fund company, often across multiple 00:21:05.059 --> 00:21:08.259 accounts, including, say, those held by your 00:21:08.259 --> 00:21:10.220 spouse and children in the same fund family. 00:21:10.990 --> 00:21:13.089 They look at your current aggregate holding to 00:21:13.089 --> 00:21:15.829 determine which breakpoint you qualify for on 00:21:15.829 --> 00:21:18.509 your new investment. So if I bought $40 ,000 00:21:18.509 --> 00:21:21.069 worth five years ago and I'm adding $10 ,000 00:21:21.069 --> 00:21:24.210 today, my $10 ,000 purchase is treated as a $50 00:21:24.210 --> 00:21:27.309 ,000 purchase for the discount calculation. Exactly. 00:21:27.309 --> 00:21:29.529 You are accumulating the right to a lower fee. 00:21:29.769 --> 00:21:32.869 And what about the letter of intent, the LOI? 00:21:33.089 --> 00:21:36.869 The LOI is a formal non -binding agreement where 00:21:36.869 --> 00:21:38.910 you state your intention to invest a certain 00:21:38.910 --> 00:21:41.589 amount over a specific period. usually 13 months, 00:21:41.849 --> 00:21:44.670 to qualify for Breakpoint today. For example, 00:21:44.710 --> 00:21:47.049 you sign an LOI saying you intend to invest $100 00:21:47.049 --> 00:21:50.390 ,000 over the next year. Based on that promise, 00:21:50.589 --> 00:21:52.789 all your purchases start immediately receiving 00:21:52.789 --> 00:21:55.650 the discount for the $100 ,000 level, even if 00:21:55.650 --> 00:21:58.390 you've only put in $20 ,000 so far. That's powerful. 00:21:58.529 --> 00:22:00.970 What if I failed to meet the target? The LOI 00:22:00.970 --> 00:22:03.829 usually has a custodial requirement. Shares are 00:22:03.829 --> 00:22:06.480 often held in escrow. If you fail to meet the 00:22:06.480 --> 00:22:08.680 target, the fund may liquidate some of those 00:22:08.680 --> 00:22:10.640 escrowed shares to recover the difference between 00:22:10.640 --> 00:22:12.900 the discounted load you paid and the higher load 00:22:12.900 --> 00:22:15.440 you actually qualified for. So it's flexible, 00:22:15.599 --> 00:22:18.259 but there are consequences. The action item is 00:22:18.259 --> 00:22:21.400 clear. Do not buy Class A shares without asking 00:22:21.400 --> 00:22:24.420 about ROA and signing an LOI if you plan to invest 00:22:24.420 --> 00:22:26.960 more over the next year. That is precisely right. 00:22:27.079 --> 00:22:29.619 Use the volume discount you've earned or promised 00:22:29.619 --> 00:22:31.900 to earn. Okay, now that we have all the components, 00:22:32.079 --> 00:22:34.539 let's synthesize this into a deeper dive on the 00:22:34.539 --> 00:22:37.000 share class structure itself. This comparison 00:22:37.000 --> 00:22:39.240 is essential. You have to understand which class 00:22:39.240 --> 00:22:41.940 serves which timeline best. Let's start again 00:22:41.940 --> 00:22:44.740 with Class A shares. Class A imposes the front 00:22:44.740 --> 00:22:47.319 -end load. Their structure is designed for long 00:22:47.319 --> 00:22:50.000 -term investors, or those making large one -time 00:22:50.000 --> 00:22:52.460 investments. They have the lowest annual expenses 00:22:52.460 --> 00:22:55.680 and the lowest 12B1 fee, meaning the compounding 00:22:55.680 --> 00:22:58.940 drag of fees is minimized over decades. and their 00:22:58.940 --> 00:23:01.960 load is reduced via breakpoints. Next, Class 00:23:01.960 --> 00:23:05.779 B shares. Class B operates under the CDSC, or 00:23:05.779 --> 00:23:08.640 back -end load, structure. Zero upfront commission. 00:23:08.960 --> 00:23:12.019 They impose higher annual 12B1 fees than Class 00:23:12.019 --> 00:23:14.359 A to cover the advance commission paid to the 00:23:14.359 --> 00:23:16.980 broker. The key feature here is the conversion 00:23:16.980 --> 00:23:19.500 Class B shares might automatically convert to 00:23:19.500 --> 00:23:22.059 Class A shares after the CDSC period expires, 00:23:22.140 --> 00:23:24.599 typically 7 to 10 years. Wait, why would they 00:23:24.599 --> 00:23:26.779 convert? Because once that commission period 00:23:26.779 --> 00:23:29.160 is over, There's no real reason to charge the 00:23:29.160 --> 00:23:32.099 high 12B1 fee anymore. By converting to Class 00:23:32.099 --> 00:23:34.900 A, the investor trades that expensive B structure 00:23:34.900 --> 00:23:37.500 for the significantly lower annual cost structure 00:23:37.500 --> 00:23:40.319 of the Class A shareholder. It optimizes the 00:23:40.319 --> 00:23:42.000 cost for the rest of their investment horizon. 00:23:42.339 --> 00:23:44.700 So Class B is essentially a high -cost transition 00:23:44.700 --> 00:23:47.079 strategy for investors who can't afford the upfront 00:23:47.079 --> 00:23:48.740 load but are certain they'll hold for at least 00:23:48.740 --> 00:23:51.289 seven years. Precisely. If you're unsure you'll 00:23:51.289 --> 00:23:54.470 hold it that long, the CDSE is punitive. If you 00:23:54.470 --> 00:23:56.769 hold it for life, it converts, and you eventually 00:23:56.769 --> 00:23:59.349 get the low annual cost. And finally, Class C 00:23:59.349 --> 00:24:02.390 shares, the no -load option. Class C shares generally 00:24:02.390 --> 00:24:05.690 have the highest perpetual annual expenses. They 00:24:05.690 --> 00:24:07.769 might have a small, short -term back -end charge, 00:24:07.930 --> 00:24:10.450 but their defining feature is that they do not 00:24:10.450 --> 00:24:12.910 convert to another class. They maintain that 00:24:12.910 --> 00:24:16.329 high 12B1 fee and high overall expense ratio 00:24:16.329 --> 00:24:19.029 indefinitely. Can you put a dollar value on that 00:24:19.029 --> 00:24:21.869 difference over 20 years? Imagine two investors, 00:24:21.970 --> 00:24:25.390 both with a $50 ,000 position. Investor A paid 00:24:25.390 --> 00:24:29.410 a 5 % front -end load, $2 ,500, but pays half 00:24:29.410 --> 00:24:33.250 a percent TE annually. Investor C paid zero up 00:24:33.250 --> 00:24:36.769 front, but pays 1 .5 % TE annually. After 20 00:24:36.769 --> 00:24:39.849 years, assuming an 8 % return, Investor C, because 00:24:39.849 --> 00:24:42.710 of that extra 1 % annual drag, will likely have 00:24:42.710 --> 00:24:45.509 forfeited an amount far, far exceeding that initial 00:24:45.509 --> 00:24:48.809 $2 ,500 load. Class C shares are rarely suitable 00:24:48.809 --> 00:24:50.970 for long -term investing. And as we move into 00:24:50.970 --> 00:24:53.589 the regulatory limits, what's the absolute cap 00:24:53.589 --> 00:24:56.869 on that 12B1 fee under U .S. rules? Under FINRA 00:24:56.869 --> 00:25:01.109 rules, the max annual 12B1 fee is 1%, and that's 00:25:01.109 --> 00:25:05.579 broken down. a maximum of 0 .75 % for distribution, 00:25:05.839 --> 00:25:08.440 which is marketing and sales, and a max of 0 00:25:08.440 --> 00:25:11.940 .25 % for shareholder servicing. No fund can 00:25:11.940 --> 00:25:14.019 charge you more than 1 % of your assets every 00:25:14.019 --> 00:25:16.359 year for that. Okay, now we get to the really 00:25:16.359 --> 00:25:18.819 sophisticated accounting. Let's talk about waivers, 00:25:18.839 --> 00:25:21.440 reimbursements, and recoupments. This is the 00:25:21.440 --> 00:25:24.079 fine print investors need to check, especially 00:25:24.079 --> 00:25:26.400 for newer funds. This addresses the financial 00:25:26.400 --> 00:25:29.440 reality of launching a new mutual fund. When 00:25:29.440 --> 00:25:32.210 a fund is small, Its fixed operating costs like 00:25:32.210 --> 00:25:35.750 rent or audit fees can look enormous as a percentage 00:25:35.750 --> 00:25:38.589 of total assets. To make the fund look competitive, 00:25:38.829 --> 00:25:41.329 the advisor might enter into a waiver or reimbursement 00:25:41.329 --> 00:25:43.490 agreement. So the advisor temporarily absorbs 00:25:43.490 --> 00:25:45.769 some of the costs to keep the reported expense 00:25:45.769 --> 00:25:48.630 ratio low. They eat the cost to attract assets. 00:25:48.930 --> 00:25:51.529 Precisely. They temporarily reduce expenses to 00:25:51.529 --> 00:25:54.430 a predetermined lower level. But here is the 00:25:54.430 --> 00:25:57.109 critical catch. The recoupment provision. The 00:25:57.109 --> 00:26:00.279 moment of repayment. Sometimes. These waived 00:26:00.279 --> 00:26:03.220 amounts must be repaid, or re -hooped, by the 00:26:03.220 --> 00:26:06.160 fund later on. This repayment period is often 00:26:06.160 --> 00:26:09.059 capped, generally not exceeding three years from 00:26:09.059 --> 00:26:11.380 when the original expense was incurred. This 00:26:11.380 --> 00:26:13.579 means the advisory firm gets to claw back the 00:26:13.579 --> 00:26:16.259 money it temporarily waived once the fund is 00:26:16.259 --> 00:26:18.099 big enough to absorb it. Let's walk through an 00:26:18.099 --> 00:26:21.059 example, a fictional fund over a few years. Year 00:26:21.059 --> 00:26:24.000 one. The fund is new, $10 million in assets. 00:26:24.539 --> 00:26:27.640 Actual costs are 1 .5%. The advisor weighed 0 00:26:27.640 --> 00:26:31.980 .6 % to meet a 0 .9 % cap. The advisor just incurred 00:26:31.980 --> 00:26:34.920 an obligation of $60 ,000 that the fund now owes 00:26:34.920 --> 00:26:38.339 back. Year two. The fund grows to $100 million. 00:26:38.759 --> 00:26:41.059 The actual expense ratio drops because of scale, 00:26:41.240 --> 00:26:43.339 but the advisor starts a recoupment process, 00:26:43.619 --> 00:26:45.440 maybe claiming an extra tenth of a percent that 00:26:45.440 --> 00:26:48.119 year. Year three. The fund keeps growing, but 00:26:48.119 --> 00:26:49.960 must continue to pay off that year one deficit. 00:26:50.359 --> 00:26:52.119 But hold on, here is the devastating implication. 00:26:52.519 --> 00:26:54.900 The fund is repaying costs incurred before I 00:26:54.900 --> 00:26:57.140 even bought my shares. That is the astonishing 00:26:57.140 --> 00:27:00.779 truth. If a recoupment plan is in effect, future 00:27:00.779 --> 00:27:03.940 shareholders who join in year three or four may 00:27:03.940 --> 00:27:06.539 be required to absorb expenses the fund incurred 00:27:06.539 --> 00:27:09.500 in prior years. You are paying to reimburse the 00:27:09.500 --> 00:27:11.579 advisor for marketing expenses they waived when 00:27:11.579 --> 00:27:14.220 the fund was tiny. and it's buried deep in the 00:27:14.220 --> 00:27:16.700 prospectus. That is a phenomenal piece of knowledge. 00:27:16.759 --> 00:27:19.259 You must check the prospectus for any ongoing 00:27:19.259 --> 00:27:22.380 recoupment obligations. Now let's move to a key 00:27:22.380 --> 00:27:25.059 mathematical insight, the predictiveness of expenses, 00:27:25.440 --> 00:27:28.579 fixed versus variable costs. This is fundamental. 00:27:28.859 --> 00:27:30.900 We're always warned that past performance is 00:27:30.900 --> 00:27:33.299 not predictive of future returns, but here is 00:27:33.299 --> 00:27:36.460 the inverse truth. Expenses are remarkably predictive. 00:27:37.069 --> 00:27:39.890 Funds with high expense ratios tend to continue 00:27:39.890 --> 00:27:42.150 having high expense ratios. Why is that certainty 00:27:42.150 --> 00:27:44.970 so high? Why can't a successful fund, once it 00:27:44.970 --> 00:27:47.730 hits $20 billion in assets, suddenly lower its 00:27:47.730 --> 00:27:49.569 costs because of efficiency? Because of how the 00:27:49.569 --> 00:27:52.029 costs are structured. While funds have some fixed 00:27:52.029 --> 00:27:54.470 costs, like an office lease or audit fees, the 00:27:54.470 --> 00:27:56.349 majority of their expenses, especially the largest 00:27:56.349 --> 00:27:58.990 ones, behave as variable costs in total dollars, 00:27:59.109 --> 00:28:01.190 but as fixed costs as a percentage of assets. 00:28:01.549 --> 00:28:04.029 That sounds contradictory. Walk me through the 00:28:04.029 --> 00:28:07.079 math. Let's focus on the management fee. If the 00:28:07.079 --> 00:28:10.440 advisory contract states a 0 .75 % management 00:28:10.440 --> 00:28:13.200 fee, that fee is fixed on a percentage basis. 00:28:13.660 --> 00:28:16.740 If the fund has $10 million in assets, the fee 00:28:16.740 --> 00:28:20.400 is $75 ,000. If the fund grows to a billion in 00:28:20.400 --> 00:28:23.720 assets, the fee automatically becomes $7 .5 million. 00:28:24.140 --> 00:28:28.819 The percentage consumed remains 0 .75 % regardless 00:28:28.819 --> 00:28:31.960 of how large the fund gets. I get it. A fixed 00:28:31.960 --> 00:28:35.140 cost like a $100 ,000 audit fee becomes a negligible 00:28:35.140 --> 00:28:37.599 percentage of a billion dollar fund. That efficiency 00:28:37.599 --> 00:28:40.140 is passed on. But the massive variable cost, 00:28:40.380 --> 00:28:43.480 the management fee, keeps taking the same percentage 00:28:43.480 --> 00:28:45.740 bite, completely neutralizing the gains from 00:28:45.740 --> 00:28:48.480 scale. Exactly. Since the management fee is locked 00:28:48.480 --> 00:28:50.839 in as a percentage and it's the dominant expense, 00:28:51.259 --> 00:28:54.019 it's extremely difficult for a fund to dramatically 00:28:54.019 --> 00:28:56.880 lower its expense ratio. If you buy a fund with 00:28:56.880 --> 00:28:59.940 a 1 .2 % expense ratio today, you should fully 00:28:59.940 --> 00:29:02.819 expect it to be 1 .2 % 10 years from now. That 00:29:02.819 --> 00:29:05.099 insight alone changes how you screen investments. 00:29:05.579 --> 00:29:08.460 The expense ratio is a permanent feature, not 00:29:08.460 --> 00:29:10.920 a temporary condition waiting to improve. Treat 00:29:10.920 --> 00:29:13.859 the TE -er as the most reliable unmoving number 00:29:13.859 --> 00:29:16.480 in the entire prospectus. Finally, let's tie 00:29:16.480 --> 00:29:18.220 this math back to your portfolio through the 00:29:18.220 --> 00:29:21.119 context of the asset class. Expenses matter relative 00:29:21.119 --> 00:29:23.839 to investment type. This is the essential so 00:29:23.839 --> 00:29:26.940 what of the entire deep dive. The acceptability 00:29:26.940 --> 00:29:29.839 of an expense ratio depends entirely on the historical 00:29:29.839 --> 00:29:32.779 return potential of the asset class. You have 00:29:32.779 --> 00:29:35.700 to gauge the cost as a percentage of your expected 00:29:35.700 --> 00:29:38.220 profit, not just as a percentage of your capital. 00:29:38.380 --> 00:29:41.180 We'll use three broad categories, equity, bond, 00:29:41.480 --> 00:29:43.859 and money market funds. Start with equity funds. 00:29:43.940 --> 00:29:45.980 Equity funds historically are the highest return 00:29:45.980 --> 00:29:48.819 category. Let's assume a long -term gross return 00:29:48.819 --> 00:29:52.349 of 10%. If that fund charges a 1 % expense ratio, 00:29:52.730 --> 00:29:55.269 the fee consumes approximately 10 % of your total 00:29:55.269 --> 00:29:58.869 gross return. While 1 % is still high, the massive 00:29:58.869 --> 00:30:01.569 growth engine softens the blow a bit. Now bond 00:30:01.569 --> 00:30:04.650 funds. Lower return potential, usually less volatile. 00:30:04.910 --> 00:30:07.910 If the historical gross return for a bond fund 00:30:07.910 --> 00:30:12.569 is, say, 8%, that same 1 % expense ratio now 00:30:12.569 --> 00:30:15.890 consumes about 12 .5 % of your return. You're 00:30:15.890 --> 00:30:18.849 forfeiting an extra 2 .5 % of your profit just 00:30:18.849 --> 00:30:20.890 by moving into a slightly lower returning asset 00:30:20.890 --> 00:30:23.230 class, even though the fee percentage is the 00:30:23.230 --> 00:30:25.829 same. The damage increases. And the most dramatic 00:30:25.829 --> 00:30:29.049 example, money market funds. They have the lowest 00:30:29.049 --> 00:30:32.240 historical returns, maybe 5 % over time. That 00:30:32.240 --> 00:30:35.339 1 % expense ratio in this context consumes a 00:30:35.339 --> 00:30:38.039 massive 20 % of your historical total return. 00:30:38.259 --> 00:30:40.500 One fifth of your profit just goes to operational 00:30:40.500 --> 00:30:43.420 fees. That changes everything. You have to be 00:30:43.420 --> 00:30:46.039 hyper aggressive about cost control here. You 00:30:46.039 --> 00:30:49.240 must. This just reinforces the need to evaluate 00:30:49.240 --> 00:30:52.619 the fee against the asset class. A 1 % fee is 00:30:52.619 --> 00:30:55.019 dramatically more destructive to a fixed income 00:30:55.019 --> 00:30:57.559 or money market investor than it is to an equity 00:30:57.559 --> 00:31:00.339 investor. The lower the expected return, the 00:31:00.339 --> 00:31:03.019 more imperative it is to pursue the absolute 00:31:03.019 --> 00:31:05.559 lowest expense ratios you could find. This deep 00:31:05.559 --> 00:31:08.140 dive has fully illuminated the dark corners of 00:31:08.140 --> 00:31:10.160 the prospectus. Let's bring it all back together 00:31:10.160 --> 00:31:12.720 for a final synthesis. We reviewed the three 00:31:12.720 --> 00:31:15.220 main buckets of charges. We started with the 00:31:15.220 --> 00:31:18.180 immediate direct payments, transaction fees, 00:31:18.420 --> 00:31:21.480 purchase, redemption, exchange, which goes straight 00:31:21.480 --> 00:31:23.220 to the fund. Then we looked at the recurring 00:31:23.220 --> 00:31:26.299 draw from the fund's assets, the periodic fees. 00:31:26.829 --> 00:31:29.329 That includes the massive management fees, those 00:31:29.329 --> 00:31:32.170 punitive account fees for small investors, and 00:31:32.170 --> 00:31:35.930 the crucial 12B1 fees, which facilitate that 00:31:35.930 --> 00:31:38.829 no -load marketing claim. And we highlighted 00:31:38.829 --> 00:31:41.589 that critical hidden expense transaction costs 00:31:41.589 --> 00:31:44.289 from high portfolio turnover, which aren't in 00:31:44.289 --> 00:31:47.099 the reported TER. And finally, we covered the 00:31:47.099 --> 00:31:49.640 loads front, back, and level. These are the commissions 00:31:49.640 --> 00:31:52.279 paid to the broker directly tied to the share 00:31:52.279 --> 00:31:55.200 class structure of A, B, and C. We saw how the 00:31:55.200 --> 00:31:57.799 true cost is the total expense ratio plus hidden 00:31:57.799 --> 00:32:00.180 transaction costs plus any upfront commission. 00:32:00.420 --> 00:32:02.500 So you now have the tools to understand the why 00:32:02.500 --> 00:32:04.920 and the how of every mutual fund charge. This 00:32:04.920 --> 00:32:07.000 empowers you to move from just passively receiving 00:32:07.000 --> 00:32:09.400 information to actively making a decision. What's 00:32:09.400 --> 00:32:11.799 the final actionable set of takeaways from all 00:32:11.799 --> 00:32:14.299 this complexity? Your power lies in focusing 00:32:14.299 --> 00:32:17.039 on minimization. You have to ruthlessly focus 00:32:17.039 --> 00:32:19.599 on minimizing annual expenses, especially in 00:32:19.599 --> 00:32:22.359 low -return environments like bond funds. If 00:32:22.359 --> 00:32:24.200 you're considering Class A shares for a large 00:32:24.200 --> 00:32:26.460 investment, you must investigate breakpoints 00:32:26.460 --> 00:32:28.619 and use rights of accumulation and letters of 00:32:28.619 --> 00:32:31.579 intent to get the maximum discount. And critically, 00:32:31.859 --> 00:32:34.940 be very wary of the high persistent annual costs 00:32:34.940 --> 00:32:38.279 of Class C no -load shares. The zero upfront 00:32:38.279 --> 00:32:41.180 commission is a psychological comfort, but the 00:32:41.180 --> 00:32:44.140 long -term drag will cost you far more over a 00:32:44.140 --> 00:32:46.319 multi -decade. investing horizon. Brilliant. 00:32:46.559 --> 00:32:48.480 And let's leave you with one final provocative 00:32:48.480 --> 00:32:50.019 thought that builds on what we learned today 00:32:50.019 --> 00:32:52.549 about the mathematics of cost. We established 00:32:52.549 --> 00:32:55.190 that a fund's high expense ratio is highly predictable 00:32:55.190 --> 00:32:57.289 because the majority of those costs, the management 00:32:57.289 --> 00:33:00.089 fee, are locked in as a constant percentage of 00:33:00.089 --> 00:33:02.470 assets. If a successful fund grows from $100 00:33:02.470 --> 00:33:05.430 million to $10 billion and its advisor's revenue 00:33:05.430 --> 00:33:08.230 increases 100 -fold without them having to dramatically 00:33:08.230 --> 00:33:11.089 lower the percentage they charge you, what truly 00:33:11.089 --> 00:33:13.609 forces a fund advisor to aggressively lower the 00:33:13.609 --> 00:33:16.109 expense ratio once it has established its history 00:33:16.109 --> 00:33:19.309 and the asset base is large? That decision to 00:33:19.309 --> 00:33:21.970 reduce the percentage fee. is almost entirely 00:33:21.970 --> 00:33:25.710 driven by competition, not by any intrinsic operational 00:33:25.710 --> 00:33:27.849 efficiency that they're mandated to share with 00:33:27.849 --> 00:33:31.009 you. The incentive to save you money often comes 00:33:31.009 --> 00:33:33.289 from outside the fund, not from within. Think 00:33:33.289 --> 00:33:35.569 about that next time you see a massive fund with 00:33:35.569 --> 00:33:37.910 a high expense ratio. That's all for this deep 00:33:37.910 --> 00:33:39.309 dive. We'll see you next time.