Mutual funds are everywhere. They are in your retirement accounts, your IRAs, your variable annuities and your variable insurance policies. So it is of paramount importance you understand a little bit about them, their fees and how to invest in them to maximize your various investments.

Mutual funds represent money you invest in “investment companies”. These investment companies may be "closed-end" or "open-ended" investment companies. Closed-end investment companies simply mean that once the investment company sells all of their "units" in the company (units are like shares of stock that public companies sell) they cannot issue more units to more investors. The investment is essentially locked and new investors are not permitted. Open-ended investment companies, on the other hand, allow continuous investment by new or old investors. They generally issue new units to satisfy the desire of investors to invest in the company. For purposes of this article we will focus on open-end investment companies, which are, for the most part, what we commonly refer to as mutual funds.

A mutual fund is a pool of money from many investors which invests that money in stocks, bonds, short-term money market instruments, and/or other securities. There are more than 8,000 mutual funds in the U.S., so selecting the right fund can be a confusing, frustrating and time consuming proposition. Many novice investors invest in the “best” performing mutual funds, which are listed by the leading personal finance magazines. The problem with this type of investing, called “chasing the leaders”, is that oftentimes these “best” performing mutual funds are not repeat performers and investors experience lackluster performance the following year. Selecting a mutual fund without the assistance of a financial professional is not a very good idea. Financial professionals who sell mutual funds have already vetted out the funds that are repeat performers with consistent track records of performance and stay away from “timing” a mutual fund investment. A good rule of thumb that I use in my financial services practice is to find those funds that have been in existence ten years or more and that return at least 9% or more on average.

Investing in mutual funds requires a little bit of knowledge about the following items:

1. Mutual Fund Class

2. Mutual Fund Fees

3. Mutual Fund Investment Objective

4. Mutual Fund Category

Mutual Fund Class

Mutual Funds typically offer three classes: class A shares, class B shares and class C shares. The principle differences between the classes are the fees charged by each class. Class A shares charge something called a "front-end sales load" ("front-end load"). A front-end load is a sales charge of approximately 4-6% that comes right off the amount invested. For example, if you invest $100,000 in a class A share that charges 5%, the amount that is actually invested is only $95,000. Class B shares generally don’t have an upfront load but typically have something called a “contingent deferred sales load” (“back-end load”). This fee is assessed when an investor sells their mutual fund shares. The longer you hold the class B shares, the lower the back-end load. For example, let’s assume you own a class B share with a net asset value of $10,000, and which has a gradually declining back-end load of 5% in year one, 4% in year two, 3% in year three, 2% in year four, 1% in year five and 0% after being held for five years. If you were to sell your class B shares for $10,000 in year three, you would be assessed a back-end load of $300. If you held on to the shares until year six you could sell without any back-end load. Class C shares generally are known as "no-loads& as they do not typically charge either a front-end load or a back-end load. Many “do it themselves” investors choose to invest in class C shares, to avoid these two fees.

Mutual Fund Fees

Mutual Funds all charge fees. The three most significant fees are:

1. Sales Fees

2. 12b-1 Fees and

3. Management Fees

The sales fees are the front-end and back-end loads we mentioned above. These fees are really commissions paid to the broker-dealer selling the fund shares to the investors. The Securities and Exchange Commission ("SEC") limits these loads to 8.5%, however, most funds charge significantly less than this. Most charge an average of 4-5%.

12b-1 fees are the dark secret of the mutual fund industry. These fees are for distribution and marketing costs that are passed on to the investor. But what does "distribution and marketing costs" mean in layman’s terms? What they really represent are hidden commissions the mutual fund company pays to the broker-dealer who sells an investor the fund shares. The SEC limits these fees to 1%. 12b-1 fees are lowest for class A shares (typically .25% - .5%) and greatest for class B and class C shares (.75% - 1%). These fees are assessed each year by the mutual fund. If you are a long-term investor it makes much more sense to invest in class A shares rather than class B or C shares, due to these 12b-1 fees. If you are going to hold on to the fund for 5 years or less, than class B or class C may make more sense.

Management fees are annual fees charged by the mutual fund for a whole host of costs that are passed on to the investor. They typically run about 1% of the fund’s value every year. Every class has these fees and in most cases the percentage is the same.

Each mutual fund may have additional fees such as annual fees (typically $35-$50/ year), initial account set-up fees, transfer fees for switching between funds, processing fees for closing accounts, advisory fees and special account management and reporting fees.

Mutual Fund Investment Objectives

Each mutual fund has it’s own unique objective. Typical objectives include the following:

• Investing in strictly U.S. stocks
• Investing in foreign stocks
• Investing in U.S. company bonds
• Investing in state and local bonds
• Investing in dividend paying stocks
• Investing in small, mid-cap or large growth stocks
• Investing in small, mid-cap or large value stocks (looking for companies trading at a price which is considered low)
• Investing in environmentally friendly companies (“Green Funds”)
• Investing in companies from a particular sector

Mutual Fund Category

Morningstar lists over 48 categories of mutual funds, but we will stick with seven key categories:

• Small, midsize or large-company growth funds
• Small, midsize or large-company value funds
• Small, midsize or large-company blend funds
• Small, midsize or large foreign companies
• Small, midsize or large-company sector funds
• Fixed Income Funds
• Allocation Funds

Growth funds are invested in companies that the fund managers’ hope will have larger profits down the road. They are long-term investments and can have greater risk than other mutual fund investments. Value funds are what I like to call the "Warren Buffet-type" investments. Warren Buffet is famous for investing in companies at a price that is trading at less than its real value. What real value "is" is anybody’s guess and therein lies the problem. A discounted price to some managers may be too high for others. It’s a science but it’s also an art form. Warren Buffet is best at it and everyone else is his redheaded stepchild, in comparison. I find value funds the hardest funds to invest in, so I try to keep only a small percentage of my clients’ money invested in them. Blend funds are, in its simplest terms, a combination of investing in growth funds and value funds. Foreign-company stocks more often than not focus on countries in Europe, Asia, North America (other than U.S.), and South America. These are higher-risk investments but also can produce the greatest return. Sector Funds invest in specific industries such as automobile manufacturers (i.e. Ford/GM), energy companies (i.e. Exxon/Mobile), technology companies (i.e. Intel/Microsoft), real estate, gold and precious metals, pharmaceuticals (i.e. Merck/Johnson and Johnson), biotechnology companies, mining companies, entertainment companies, media companies etc. These funds are very specific and particularly sensitive to changes in economic conditions. Fixed income funds include U.S. company bonds, U.S. treasuries and state & local bonds. These investments are the most conservative in terms of risk. Allocation funds are the most diversified of all of the mutual fund investments, in my opinion, and generally include something called "rebalancing", which keeps the investment objectives consistent each year. In many cases these funds invest in other mutual funds. For example, a "moderate allocation fund" might include ten underlying mutual funds in its investment portfolio, each of which is invested in companies that may be considered “blue-chip” companies.

As you can see investing in mutual funds can be complicated. For the "do it themselves" investors out there, there are many sources of information on mutual funds found in the leading investment magazines. You can also go to the public library and browse the Morningstar 500 mutual fund guide or surf the Internet for the right fund. My suggestion, however, is to find yourself an experienced investment professional to help guide you in selecting the mutual funds that are right for your level of risk tolerance. A good investment advisor will ask a lot of questions before asking you how much you have to invest and they will steer you to funds that have had a long record of consistent performance and with managers who have been with the fund for a long time or who have had their own record of winning results.