There are more costs associated with a mutual fund than you know about.

"Investment managers sell for the price of a Picasso what routinely turns out to be paint-by-number art."

- Patricia C. Dunn, CEO, Barclays Global Advisors (World's largest money management firm, approximately $1 trillion of assets under management, 80% indexed.)

Funds are often sold with a sales charge, known as a load. Buying or selling a stock always involves a commission. Those charges are easy to see. Less obvious are the annual fees charged by the fund manager and the costs of all those trades they make as they pursue profits on your behalf. Even harder to see, until the end of the year, are the costs associated with taxes. None of these costs are explained in the sales brochures that investment advisors hand out.

Altogether, these costs can add up to 25% of the total possible returns from stock market gains. What could have been a 10% annual rate of return may be reduced to 7.5% just from all the costs associated with owning a good performing, actively managed mutual fund. Given the difficulty of identifying the best performers in advance, you are likely to see even worse returns. Costs and an inability to always invest in the biggest winners leave most investors significantly underperforming the market.

Many investors mistakenly believe that no-load funds are free of all costs. Nothing could be further from the truth. Although there is no "entrance fee" for acquisition, no-load funds impose management fees of as much as 1.5% and in addition the marketing and administrative costs come out of the funds themselves. Total costs can easily amount to 2.5% or more for no-load funds.

Load funds do no better than no-load funds

When an investment advisor recommends a fund to a client, that fund will usually be a load fund, and the load is pocketed by the broker and/or other middlemen as payment for providing the service of helping you pick a good fund. These loads range from a few percent of your initial investment to as much as 8.5% of your hard-earned nest egg.

The first thing your investment advisor should be required to tell you is that there is no real difference historically between the performance of load funds and no-load funds in terms of performance. No-load funds allow you to invest directly without having to pay any sales charges to the fund or an investment advisor. In fact, according to a Morningstar study, even when the negative effects of the load are excluded from a performance evaluation, no-load funds actually have a superior record to load funds over the 3 and 5 year periods ending in 2006.

To summarize that study, "Funds that don't impose any costs to purchase them have outperformed those that investment advisors charge you to find."

Many investors access equities through annuity products where commissions and charges are far greater than these, and there are frequently additional costs to liquidate before due dates.

Annual fees come off the top

"Active management means that the compounding burdens of fees and taxes largely offset your compounding portfolio growth."

- RVW's Wisdom

Mutual funds charge management, marketing and administrative fees for managing your money. Most investors never see the total because the layers of fees are detailed in the fine print of the prospectus and annual reports or paid to sub-managers. While it is tough to argue against management fees, they can be 3% or more per year, and average 1.2% in addition to the other costs and charges that flow through to investors in these funds.

Marketing fees seem like price gouging. More formally known as distribution fees or 12b-1 fees, these are collected from existing shareholder accounts to cover distribution expenses and may also be used to fund shareholder service expenses. The "12b-1 fees" get their name from the SEC rule that authorizes a fund to pay them. Distribution fees include such things as fees paid for marketing and selling fund shares, and include the expense of compensating brokers and investment advisors who sell fund shares, paying for advertising, the printing and mailing of prospectuses to possible investors, and the printing and mailing of sales literature. Regulators limit fees for marketing to 0.75% a year.

Mutual funds may be the only business model where current customers are explicitly charged advertising expenses. Most other businesses would budget for this expense and use the dollars wisely. With mutual funds, they can spend more as they grow, and the advertising agencies know this so they meet the needs of the client and create more advertising campaigns. There are no studies that show larger funds outperform smaller funds, and in fact, it becomes harder for active managers to follow their disciplined approach as they grow. This means the marketing fees might actually hurt future performance, while costing you current earnings.

Little, if any, training is required to become an investment advisor

Offering financial advice has become a growth industry in recent years. To serve the public, all you have to do is pass an exam to sell insurance or pass a test related to the securities industry.

After passing the test and being approved by the state authorities or the S.E.C, the newly minted mayven is legally permitted to give advice regarding nestegg investments and long term retirement planning. Usually he has no significant income tax or estate planning training and has no serious understanding about economics or accounting – all fields that are essential for financial advisors.

Certain investments pay the advisor more than other investments

"Your stockbroker earns money from you, not for you."

- RVW's Wisdom

Mutual fund families often employ salesmen to sell their funds to the salesmen who will then sell it to you. These layers of salesmen can be expensive, so they need to deliver results. As many companies know, one of the best ways to boost sales is to boost commissions or offer incentives to the sales force. This ultimately leads to higher prices for the end consumer or an inferior product. In the investment business, often the best product for the client, such as low-cost index funds, ends up paying the lowest commission to the planner. Your stock broker likely gets fully paid deluxe cruises and other vacations provided by those institutions where he has placed the requisite threshold of business, hardly a mark of his objective advice.

Mutual funds come in A, B, and C shares and "house funds". All four are bad for you

he complex fee structure confuses investors, and makes it easier for investment advisors and fund managers to make more money.

Class A shares charge a front-end load, which reduces the amount you initially invest in the fund. A 5% load means that only $9,500 of every $10,000 investment goes to work for you. The funds may also charge a 12b-1 fee, but it's generally the lowest 12b-1 fee of any share class. These shares are typically sold with breakpoints, which are similar to volume discounts, meaning the more you buy, the less you pay. The first breakpoint for many load funds is $50,000. Loads continue to drop at various breakpoints, and typically disappear entirely at $1,000,000.

Class B class shares don't charge a front-end load, but they often impose a sizable 12b-1 fee. These shares also normally carry a contingent deferred sales charge (CDSC), which investors pay when they sell their shares. The CDSC declines over a number of years, and it's eventually eliminated if the shares are held long enough. Once the CDSC is eliminated, Class B shares typically convert into Class A shares and at that point, the 12b-1 fee paid by both classes is identical. Mutual fund companies and investment advisors claim that deferred sales charges encourage long-term holding by imposing a penalty on you if you sell before they think you should.

Class C class shares typically charge the maximum permissible 12b-1 fee, a total of 1%, and they carry a small CDSC of 1% or 2% for the first year or two after you buy the fund. But the 12b-1 fee remains high the entire time that you own the fund.

House funds are private brands offered by all the major brokerage firms, It seems logical that Wall Street power houses would have the best information to base investment decisions on, and you would expect their mutual funds to be among the top performers year after year. Studies show that house funds fare worse than independently managed funds. Most house funds pay larger commissions to the salesman, putting their interests directly in conflict with yours.

Wrap accounts wrap fee upon fee into a single account

A popular investment sold by investment advisors is known as a wrap accounts, in which all account costs are allegedly "wrapped" into a single fixed fee. Charges of 1-3% of the accounts assets are deducted from the balance on a regular basis, and pay for all trading, administrative, research, and advisory expenses.

Investment advisors sell these accounts claiming that one advantage to a wrap account is that it protects investors from churning to avoid trading an account excessively to generate extra commissions. You are being asked to pay a high fee to ensure that your advisor doesn't cheat you.

With mutual funds, which are often held in wrap accounts, you are actually being charged twice. The mutual fund manager still charges full fees, costing you 5-6% of your potential annual returns if you allow your investment advisor to sell you a wrap account. Half of the stock market's average gains could be lost to fees.

Finally, the SEC realized that wrap accounts did not help investors and took action to stop this industry abuse. In late 2007, they ordered brokers and advisors to stop offering these accounts. The industry responded with prompt compliance, and converted many client wrap accounts into another type of account known as a "fee-based nondiscretionary advisory accounts." With these accounts, you can hold individual stocks and bonds, mutual funds, exchange-traded funds, and cash investments. Investors can get comprehensive advice from their investment adviser, but still control the final decisions since the adviser must get the client's permission before making changes to investments. Fees are based upon a percentage of assets in your account.

What your advisor might not tell you is while the fee-based nondiscretionary advisory account is legal, it looks just like the illegal wrap account. Just like with the wrap account, there are multiple layers of fees plus costs in the underlying funds, and fees associated with the managers. These accounts offer a chance for the investment advisor to portray the costs more attractively and position themselves, the salesman, as an objective judge of value. By effectively moving the other side of the table the "Investment Advisor," as they will then be known rather than a calling themselves a "stockbroker," secures a large regular income and positions himself to retain you, and more importantly your assets, even if a particular manager underperforms.

Selling bonds to you is the most lucrative place for your broker to expend his energies

You have no idea how much profit your broker will be making on your purchase of a bond because bond commissions are undisclosed. You buy from the broker's inventory at a marked up retail sales price.

The tax-free muni bond you bought may not really be tax-free after all. If you're in alternative minimum tax (a complex alternative tax computation that is punitive and may affect you) you may be better off buying a taxable bond.. For this reason the savvy investor asks his tax preparer rather than his stock broker for advice on this aspect of investing.

In the long run bonds are devastated by inflation: Between 1968 and 1982 the purchasing power of a Dollar dropped in half.

Your investment advisor does not have to act in your best interest

"Wall Street is the only place people ride to in a Rolls Royce to get advice from those who travel by subway."

- Warren Buffett

Your investment advisor does not have a fiduciary obligation to you. Brokers, in particular, are exempt from many rules that require other advisors to place the client ahead of their own interests.

In addition to the fact that it is in their best interest to sell you something, brokers have even less requirement to work on your behalf than investment advisors. Brokers are bound by the "Prudent Man Rule," which has been adopted in every state. This rule states that investing activities hold little hope of profit and your broker is not responsible for any bad advice he gives you. While you would probably never consider seeing a doctor who operated under a philosophy such as the Prudent Man Rule, this idea dominates the legal environment of the brokerage industry.

You can't argue with your broker because you have to submit to mandatory arbitration

All investors agree to this when they open a brokerage account. The advantage, according to your broker, is that you won't ever have to go to court to settle disputes, you'll use a system run by the National Association of Security Dealers and the New York Stock Exchange.

All disputes are heard by a panel of three securities experts. While you will get a fair hearing, the fact that the arbitration panel knows the rules far better than the average investor usually means that you will lose in this setting. There are no class action lawsuits and no publicity – both of which would normally discourage abuse by the brokerage industry and act as an additional protective layer for the investing public.

A study conducted by securities lawyer Daniel Solin, and Edward O'Neal, a former finance professor, shows that the arbitration win rate, meaning that investors recover money from brokers, was only 44 percent in 2004.

The research was difficult to conduct. They had to sue the NASD to obtain permission to study the awards. In the end, they obtained 14,000 NASD and NYSE arbitration records from 1995 through 2004. They found that the larger the claim, the smaller the recovery. For those with claims exceeding $250,000, only 12% of investors were successful.