Millions of investors use mutual funds in their investing. Yet whether you own mutual funds directly through fund companies, use a broker to buy them for you, or own them in a 401(k) plan or other retirement account, it's important to understand the costs that mutual funds charge. Otherwise, you could end up being a victim by paying fees you shouldn't owe.
Recently, the Merrill Lynch division of Bank of America agree to pay fines of $8 million and reimburse a total of $89 million to customers to settle allegations from the Financial Industry Regulatory Authority about overcharging on mutual funds. The case gives just one example of how financial institutions can end up charging you more than you should pay if you're not careful.
What the allegations were
In its alleged facts, FINRA set out what it believes Merrill Lynch did. Under Merrill Lynch's mutual fund platform, the brokerage firm typically charges various fees and sales loads for certain classes of shares, including upfront sales loads for Class A shares. If you're a retail customer, you'll pay these charges in order to buy Class A shares, which typically have lower ongoing annual expenses than other classes of mutual funds.
Many financial institutions have special agreements with corporate customers who have workplace retirement accounts. Under those agreements, the financial institution agrees not to charge the typical upfront sales charge for retirement-plan mutual fund purchases, instead waiving those fees and giving participants access Class A shares without a load. FINRA alleges, though, that Merrill Lynch didn't actually waive those fees, instead charging workers at 41,000 small businesses and 6,800 charities more than they should have paid. The overages either happened by charging the normal sales loads on Class A shares, or by shunting those customers into other classes of shares that didn't have an upfront load but did have higher ongoing expenses.
Even worse, FINRA says that Merrill Lynch knew about the bad behavior as early as 2006. Yet it didn't take action to fix the problem until more than five years later, instead counting on inadequately supervised financial-advisor personnel to implement fee waivers correctly. In the settlement, Merrill Lynch didn't admit or deny FINRA's charges, but the broker gave consent to FINRA's findings.
What you should watch out for
Unfortunately, mutual-fund investors need to know what they're entitled to. The easiest way to avoid problems is to stick with no-load mutual-fund providers, as they don't charge sales fees at all and only have the annual expenses of fund management for you to pay.
If you're going to stick with funds that charge sales loads, though, here are some warning signs to look out for:
You should never have to pay new sales loads on fund exchanges. Most fund families have agreements that allow in-family exchanges with no extra load.
Be aware of sales-load breakpoints. In many cases, if you make purchases above a certain dollar amount within a given period, your percentage sales load will be reduced. But especially if you make purchases in multiple transactions, many brokers won't automatically keep track of those breakpoints for you.
Make sure your fund changes classes on schedule. In many cases, if you buy Class B or C shares, they'll eventually convert to lower-expense Class A shares after a given number of years. Be familiar with the prospectus, and when that time comes, make sure your broker follows through on that promise.
Mutual funds can make investing a lot easier, but they still come with pitfalls for the unwary. It's important to keep an eye on the investment professionals who help you make the most of your money to ensure that they aren't taking unfair advantage of you.