Expenses are important

Fund expenses can be significant over time. Take an initial investment of $25,000 returning 8% over 20 years. A fund with a 0.3% expense ratio will return $19,751 more than a fund with a 1.3% expense ratio.

Trying to Build a Better Index Fund from Fortune.

Expenses, Taxes

Fund Expenses  

To review, the manager(s) of an actively managed fund seeks to exceed returns of financial markets by the aid of research, forecasts and his/her judgment. A passively managed fund such as an index fund simply tries to mirror the fund's performance to an index (e.g. S&P 500). 

See bottom half of table below. All funds have Annual Operating expenses or Expense Ratio, expenses needed to run the fund.  These consist of management and administrative fees and also 12b-1 fees. The average expense ratio is 1.5%. No-load funds have only this fee, with the exception of redemption fees for cashing out before a certain period (e.g.  90 days) - this is solely in order to discourage short-term trading. 
 
Load funds have shareholder fees (directly charged to an individual account) in
addition to the above fees. These fees may be in form of a Front-end load (deducted up-front), Contingent Deferred Sales Load (for a premature sale), Load on Reinvested dividends or Redemption fees.   

There are different load fund classes with varying sales load (charges) and expense ratios.  



As an example,  

Class A: 4.5% up-front load, 1.78% expense ratio  
Class B: Zero up-front load, 2.5% expense ratio, back-end charge of 5% that reduces to zero after 6 years.
Class C: Zero up-front load, 2.5% expense ratio, back-end charge 1% for 1 year.

Most of the load funds are actively managed funds.  Index funds have generally both no load and low expenses (about 0.18%, some are as low as 0.1% (also called 10 basis points). Beware, there are some index funds that charge a load as shown above. 

Some mutual funds have performance based fees - a higher management fee when the fund does well and a lower one when the fund does poorly.

Fund expenses can be significant over time. Use the table below to get an idea of how much $10,000 invested at 10% grows over 20 years for 4 different fee structures: No Load Index, Load Index, No Load Active and Load Active.  



The calculations below that given the same return for all the four funds, the no-load index fund is the best choice.  But if an active fund delivers higher returns than the index, a higher expense ratio (and sometimes load) may be justified. 

These calculations are enhanced at Vanguard's website, for instance, compare cost for Vanguard 500 Index Fund vs. Fidelity Contrafund. 

There are no-load clones (e.g. Selected American Shares SLASX) of load funds (e.g. Davis New York Venture).

Make sure that the fund fees of for target funds and fund of funds include the fees of the underlying funds. 

Fund taxes

There are basically three kinds of taxable events that MAY arise in owning
mutual funds:

1.  Capital gains/losses: When the sale price (NAV) is higher/lower than the buy price. 
     These are only realized when you sell the fund (in your control). Remember, a fund exchange is a fund sale.

The following two distributions are paid by some (but not all) funds to all investors periodically.

2.  Income distribution: Dividend income.
3.  Capital gains distribution: Profit from sale of securities in the fund.

Tax-efficient funds make you pay taxes later.