High costs lead to inferior bond mutual fund performance
Bond portfolio management is a relatively specialized fixed income securities activity. You might expect that certain bond mutual fund managers would be more skilled than others and would produce higher bond returns. Better performance due to investment skill could, of course, justify paying extra fees.
However, investment science has not detected a relationship between paying higher fees and obtaining better returns from the bond mutual fund industry. In fact, the opposite seems to be true. Higher expenses tend to mean lower net returns to individual investors. [See: Bond Mutual Fund Fees]
While different from the equity markets, the bond markets also tend to be relatively efficient from the standpoint of reflecting currently available information in prices. They are simply not easy to beat in the sense that it is difficult or impossible to detect and capitalize on mis-pricing. Nevertheless, transactions or trading fees are relatively high — especially for individual investors purchasing fixed income securities instead of fixed income investment funds. [See: Bond Market Index Funds]
Buy no load bond funds to get the best bond fund performance
Once an individual investor has decided to purchase shares in a bond mutual fund, the selection process can be relatively straightforward. Bond mutual funds are just another financial product being marketed to fill an investment need. The fund companies that offer them make decisions on how they will compete – whether through advertising, agents, service, word-of-mouth, etc. Some fixed income funds compete on price, i.e. lower fees, and others do not. Patronize funds that compete on price, that is, they offer rock bottom management expense ratios.
To protect your interests – instead of the interests of the mutual fund companies – you need simply to determine the style of fund you desire in terms of bond maturity and investment quality. Then, from among the funds with the lowest fees, just pick one or preferably several bond mutual funds — several for greater investment diversification — that are offered by reputable firms. If you pay higher fees, you will most likely just throw your money down a securities industry profit hole.
Just say NO to bond fund sales loads
If you are dealing with any investment counselor or financial advisor who tries to promote a bond market mutual fund with high fees and/or a bond mutual fund with a front-end load, just say no. Investment science indicates that there is no justification for paying higher expenses or a front-end load. Higher sales load expenses just tend to lower your total returns.
A front-end load just means that you are paying someone to sell you an investment. Paying extra to be sold to is hard to justify in any type of business transaction – whether in investments or in any other industry. It is easy to buy directly from bond market mutual funds and cut out the intermediary. Fixed income fund families that want your direct business all have how-to-buy information on their websites and toll free customer service telephone numbers.
Sales loads are an extremely expensive way to pay a financial advisor. If you need a financial advisor, find one who accepts hourly or fixed fee compensation and does not take any commission money from the industry through the “back door.” Also, if your financial adviser pushes fixed income investment funds with high expense ratios, this is an indication that they have not done their homework. Either that or they care more about their own compensation than they do about your financial outlook. Get a better financial advisor who will look out for your interests and save you money over the long haul.
Fixed income fund redemption fees
In addition, note that there can be a reasonable justification to pay a short-term, back-end redemption charge. If a fund has a longer average maturity and wishes to discourage shorter-term trading behavior, a redemption charge could be assessed for some limited period following a purchase to protect longer-term fund holders.
A short-term redemption charge is not a back-end load. Back-end loads pay bond financial advisors, investment counselors, and their firms. Instead, redemption charges are paid (or should be – check to find out) to the shareholders of the fund. Redemption fees should be designed to compensate long-term shareholders for any higher trading costs and/or higher short-term capital gains taxes caused by short-term share trading.
If a fund has such a redemption fee and you agree with why it is there, then you should confirm that all such fees collected are returned to the fund itself solely for the benefit of fund investors who stay in the fund for a longer period. In addition, of course, you need to make sure that it is highly unlikely that you will need to redeem your investment within this penalty window.
Note also that some very low cost no load bond market index funds may have longer-term back end redemption fees that are paid to remaining shareholders and only expire after multiple years. This is a clear signal that the fund is designed for both cost efficiency and long-term investors. A modest multi-year redemption fee (perhaps 1% or less paid upon exit before some number of years) might not be a bad idea for very low cost no load bond funds.
With a stay put, buy-and-hold shareholder clientele, you could benefit from very low annual costs, very low portfolio turnover and trading costs, and redemption fee “protection” from frequent early exits and churning by those with a short-term trading perspective. Again, consider the likelihood of you being a long-term holder who would benefit from others who exit early, versus you needing to exit early and pay the redemption fee yourself.Tags:fixed income,bond mutual funds