Why are 'buy' and 'sell' prices different?

Nov. 2003  — Q: Why, whenever I have a transaction for either a mutual fund or stock, do I buy it for the high price of the day and sell it for the low price of the day. Is the SEC monitoring these specifics or is this something that the government should also look at? Is this another can of worms for the worms? — Duane R., Chicago

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A: The difference in the two prices you’re referring to is the “spread,” and it represents the commission that is paid to the broker who executes your trade. In theory, buyers and sellers could be matched electronically. But as long as the trades are handled by human beings, they have to get paid somehow.

While fees are regulated, they vary a great deal, and high fees can quickly sap your fund of any investment gains. The NASD limits sales loads to 8.5 percent, for example, which is more than many funds are making these days.

The “spread” is one of the most visible fees: You just compare the “bid” (the price you’ll pay to buy a share) and the “ask” (the price the seller gets) and the difference represents a commission you pay. You may pay a “sales load” — the broker’s commission — on the front-end (when you buy) or back-end (when you sell) or both.

But the “spread” is only one of the costs you’ll encounter when you invest in mutual funds. The problem many individual investors have is figuring out just how much they’re paying — and where all these fees are going. That’s one of the ways that New York Attorney General Eliot Spitzer wants the industry to clean up its act — by making it much easier to figure out what you’re paying.

Until that happens, you’ll just have to dig further to find the other fees and expenses buried in the fund’s prospectus — that mind-numbing document written by lawyers that fund companies know you’re just going to throw away.

Each time the fund manager buys or sells a stock in your fund, for example, there’s a commission paid to whoever executed that trade. Funds with high “turnover” — heavy trading of its portfolio — will pay more in commissions that more stable funds. You may also be charged so-called 12b-1 fees for expenses like advertising and marketing — for all that useless junk mail your fund sends you every month trying to get you to buy other funds from the same company.

The list goes on; for details on other fund fees you may be paying, check out the Securities & Exchange Commission’s explanation.

One of the easiest ways to compare funds is to look at the so-called “expense ratio.” Though not all fees are covered, this is supposed to tell you what percentage of the funds assets are being used to pay fees and commissions to the fund manager and the various traders and brokers who get their cut. The higher the expense ratio, the more likely your fund is to lag other funds in its category, because there’s no connection between the level of fees you pay and the funds performance. In this case, you don’t necessarily “get what you pay for.”