The Disadvantages of Investing in Mutual Funds

Some mutual fund costs come directly out of your initial investment.profit/loss1 image by Warren Millar from Fotolia.com

When you buy a mutual fund, the investment company pools your money with other client's money to invest in stocks, bonds and other investment instruments. The collective investments in the mutual fund are what make up the fund's portfolio. Mutual funds have their advantages, such as spreading investment risk across different market sectors, but they also have their disadvantages.

Commissions

With the exception of no-load mutual funds, all other mutual funds have what brokers refer to as load fees. The three types of load fees are front-end, back-end and level. A front-end load fee is similar to a commission you pay to the broker when you buy shares in the fund. A back-end load fee is similar to a sales commission you pay to the broker when you sell shares in the fund. A level load fee is a fixed percentage the broker charges you for every year you keep your mutual fund.

Common fees paid for both no-load and loaded mutual funds include the cost to manage the fund, marketing, distribution and selling cost fees (referred to as 12b-1 fees), operating and accounting expenses. Other fees include purchase and redemption fees. The purchase fee is the cost you have to pay to buy the fund, but is not the same as a front-end load fee. The redemption fee is the cost you pay to redeem or sell your shares and is not the same as a back-end load fee. You pay the purchase and redemption fees in addition to front and back end loads.

All mutual fund distributions are taxable in the year the fund pays them out to you. This includes dividends you reinvest in the mutual fund. If you sell your shares, the amount you receive from the sale is subject to capital gains taxes. Even if the fund, as a whole, had a negative return in the current tax year, if the broker sells any part of the fund for a gain, you will have to pay capital gains taxes on the gain from the sale.