I’ve written before about the importance of reading a mutual fund prospectus. Just the other day as I was researching my article on low-cost, socially responsible investment options, I experienced a perfect example of why it’s so important.
According to the fund list I found, Pax World Investments’ Pax World International Fund was the lowest cost “socially responsible” international equity fund, with an expense ratio of 1.40%. But before suggesting it on the blog, I thought it would be wise to download and read the prospectus.
If you flip to page 40 (Fees & Expenses), you’ll see the real costs of running the fund. The total? 11.82% of assets! (Seriously. Go look.)
So how was it that a 1.40% expense ratio was listed elsewhere? As happens frequently in the mutual fund industry, the management company waived a portion of the expenses (in this case, almost 90% of the expenses).
The catch is that this waiver of fees isn’t permanent. In this case, it’s through 12/31/2012, but in many cases, the management company can discontinue it at any time.
Loss Leaders
Some fund companies run certain funds at a loss on an ongoing basis. For example, Schwab’s S&P 500 Index Fund only charges shareholders an expense ratio of 0.09% per year, when its gross expense ratio is 0.21%.
My understanding is that their purpose for this fund is much the same as that of milk at the grocery store: sell it at a small loss in order to bring in customers, to whom they can sell more profitable products (like higher cost, actively managed funds).
The existence of a fee waiver wouldn’t bother me much if I were pondering investing in one of Schwab’s index funds. In those cases, even if the waiver disappeared, it wouldn’t be that big of a deal as long as you noticed it within a couple years and switched to a lower cost fund. (Note: This would mean continuing to read prospectuses from time to time, even after investing in the funds.)
But that’s one big waiver!
But in the case of the Pax World International Fund, we’re not talking about a 0.12% jump in expenses if/when the waiver disappears. We’re talking about an increase in expenses equal to more than 10% of fund assets. I don’t know about you, but that would make me extremely hesitant to invest in the fund.
The Lesson: Read the prospectus
Assuming you plan to own a fund for several years, you need to know not only what its expenses are now, but what they’re likely to change to in the future. That’s the kind of information that you’ll only find in a prospectus.