Beware of Hidden Fund Costs

Over the last few years, investors have become more aware of the importance of mutual fund fees such as expense ratios, marketing fees and sales commissions. That's definitely a good thing.

But there are other kinds of costs, such as trading and taxes, that are much harder to spot and can significantly eat into returns -- enough so that you may have to put off retirement for several years.

"Even small costs can make a very significant difference over time," says Thomas McGuigan, a principal in the Old Lyme, Conn., office of Burns Advisory Group, which manages over $300 million in assets.

McGuigan is particularly concerned with funds' transaction costs, which include trading commissions and the difference between bid and offer prices on a security being bought or sold. These are not included in a fund's expense ratio, which is a measure of operating costs and management fees, and they can be hard to spot. Funds report their turnover, which is the lesser of either their purchases or sales, but not the total number of their transactions.

Depending on the type of asset, the cost of frequent trading can be quite high. McGuigan is wary of managers who churn small-cap stock portfolios, for example, since trading volume in these securities is relatively thin. That means spreads between bid and offer prices tend to be wider.