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Show it: How mutual funds make money

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The income and expenses of a mutual fund

The funds available for investment after a new fund offer are turned over to a fund manager. The fund manager is a person with considerable investment expertise. The fund manager, assisted by a team, then invests the money according to the objectives set out by the mutual fund.

In return for investing a client’s money, mutual funds charge a fee, generally an annual fee set as a percentage of the client’s assets. This fee is the only source of income for a mutual fund-focused asset management company. On the cost side, this fee is used to pay for various things such as brokerage, a manager and other employee costs, commission to salespersons, and other operational costs.

This cost structure is the same for all mutual fund players including Franklin Templeton Investments (BEN), T. Rowe Price (TROW), Legg Mason (LM), Janus Capital Group (JNS), or other mutual fund-focused asset management companies found in the Financial Select Sector SPDR Fund (XLF).

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The larger the assets, the higher the income

Larger asset amounts generally generate more income. However, the costs of running the various funds of asset management firms are fixed. These don’t vary except for a manager’s and investment team’s fees, which often varies depending on their performance.

In effect, the success of a mutual fund-focused asset management firm depends to a large degree on how the fund performs, which in turn depends on the quality of the fund manager. Successful funds see a lot of fresh money coming in.

Next in this series, we’ll move on to index funds, an important asset management class that has grown in popularity over the years.

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