Question

You have $10,000 to invest and are considering two mutual funds: No-load Fund and Economy Fund. The No-load Fund charges a 12b-1 fee of 1% and maintains an expense ratio of 0.50%. The Economy Fund charges a front-end load of 4%, but has no 12b-1 fee and an expense ratio of 0.50%. Assume that the rate of return on both funds’ portfolios (before any fees) is 8% per year.

1. If you plan to buy and hold for three years, which one should you invest? Please explain.

2. If you plan to buy and hold for ten years, which one should you invest? Please explain.

Answer 1

Answer :- 12b-1 is an annual marketing expense of an mutual fund it is considered as an operating expense of a mutual fund whereas front endoad is the fee paid for investing in mutual fund.

Situation 1:- If you plan to buy and hold for three years.

No-load fund :- The total cost of holding investment is 3%

Economy fund :- The total cost of holding investment is 4%

And 0.50% expense ratio is for both the funds which means that No load fund is better to invest.

Situation 2 :- If you plan to buy and hold for ten years.

No load fund = Total cost = 10%

Economy fund = Total cost = 4%

And 0.50% expense ratio for both the funds which means Economy fund is better to invest.