Understanding Mutual Fund Share Classes

Some mutual fund companies offer different share classes, meaning different fee structures. Although I recommend no-load funds, meaning funds that don’t include a sales commission, I think it’s worth discussing the various fee structures in the mutual fund industry.

First let’s talk about the types of loads that exist:

• Front-end loads
• Back-end loads
• Purchase fees
• Redemption fees

Note: some people don’t technically consider purchase and redemption fees a “load” because it’s not a commission to a salesman/broker.

Front-end loads typically range fro 2.5% to 5%, and are essentially a sales charge that is taken out of your investment. Funds can have up to an 8.5% front-end load! If you invest $1,000 in a fund that has a 3% front-end load, when the transaction is complete you will have $970 invested in the fund after paying $30 in fees. Yikes! I hope you’re getting your money’s worth (although it’s doubtful). For the math geeks out there you should also recognize that a 3% load is equal to $30/$970 = 3.09% of your investment.

Front-end loads are typically paid to mutual fund brokers. Purchase fees work the same way as front-end loads, but the fees go to the mutual fund management company.

Back-end loads and redemption fees, you could probably guess at this point, are costs that are due when you sell shares of a fund. Let’s say you invest $1,000, and it grows to $2,000 over a decade. When you wish to redeem your shares from a fund with a back-end load of 3%, you’ll end up with $1,940 after paying $60 in fees.

It may not seem like 2%, 3%, or even 5% is not that much in the grand scheme of things. After all, you’ll planning to be a millionaire by 30, right? Well let’s just investigate that a bit.

Millionaire plan #1: invest $50,000 today in a no-load index fund that earns 10% every year. In 33 years you’ll have $1,055,688!

Millionaire plan #2: invest $50,000 today in a fund that earns 10% every year, but charges a front-end load of 4.75. You have $1,050,233 as well, but it takes you two extra years. Over the 35 years you invested you paid $52,374 in sales fees (assuming a constant load % on every share purchase).

Millionaire plan #3: invest $50,000 today in a fund that earns 10% every year, but charges a back-end load of 4.75. You have = $1,055,688 just like #1 in 33 years, but when you withdraw the model you get charged 4.75%, or $50,145.

And here’s what you probably received for your $50,000 in lost value:

• Advise on which fund(s) to invest in after meeting with a financial adviser (broker/sales person) for a couple hours. This can be valuable when your starting out, but it’s not hard to do on your own either! Read three books on no-load mutual funds (or better yet index fund investing) and you’ll have all the know-how you need to get started, and 2%-5% more money to invest!!! Here’s a recommendation for the beginner: The Little Book Of Common Sense Investing or The Coffeehouse Investor
• Portfolio and financial planning advice. Possibly. This advice could be biased though based on how the adviser is being compensated. Just like with any profession, you need to make your own determination on who to trust.
• Average returns. Few funds, load or otherwise, outperform the market averages over an extended period of time. Furthermore, most top-performing funds in one year are well below average in following years.

This is just one of many examples that show EXPENSES COUNT when it comes to investing. And the examples above only look at the load, not the on-going expense ratio differences that will have a huge impact on your final returns as well. This also needs to be evaluated when choosing funds, including no-load and index funds.

Now let’s cover share classes. Some mutual funds come in different share classes, namely A, B, C, etc. shares. The share class is typically listed in the name of the mutual fund. There are no hard rules on the various mutual fund share class designations (A, B, Z, ect), so please read the funds’ prospectus before investing. The following discussion covers norms and an example from one fund company.

For example, there is a mutual fund called “Mutual Shares” managed by Franklin Mutual Advisor which is fairly popular and includes over $22B in assets. I picked this example out of thin air, so please don’t think I’m recommending this fund (nor do I own it or any “load” funds).

“Mutual Shares A” – A indicates a front-end load (5.75% in this case)

“Mutual Shares B” – B indicates a back-end load (4.00% in this case)

“Mutual Shares C” – C (& D) shares typically have higher expenses and are used on funds that are expected to be held only for a short amount of time. C shared are sometimes considered “level load” funds, meaning there is an extra expense paid each year (1% for example). Some also have a redemption fee depending on how long the shares are held (1.00% in this case)

“Mutual Shares R” – I have no idea what this R fund represents, and it wasn’t clear on initial glance from the data available at Morningstar.com

“Mutual Shares Z” – Z are for fund company employees

Confusing huh?

Bottom line: you don’t have to pay any loads if you purchase no-load funds. You’ll still be paying fund expenses that cover employees and overhead expenses to operate a fund, but these expenses are part of both load and no-load funds. Better yet, buy a no-load index fund and you’ll save the load and much higher expenses!

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