A Mutual Fund Share Class Discussion

There is a tremendous amount of money invested in mutual funds in the United States. In some cases people own mutual funds for their personal investments. In other cases people own mutual funds in their employer retirement plan, whether it be a 401k, 403b, Simple or Sep IRA, etc. I’ve found that the majority of people whom I meet, whether clients or otherwise, don’t know the difference between A, B, C, and other less common share classes. I find that odd considering the investor is often the person who must choose which share class they own and therefore should have at least a basic knowledge of each. However, many people leave that decision to their advisor and don’t learn the differences until after their account has been open a while or worse, when they need money and find out they are subject to some sort of deferred sales charge. Let me elaborate below so that, in the future, you know exactly what you are buying and why:

A-shares: These are often the most desirable share class to own in that they have the lowest annual expenses (with the exception of institutional share classes, sometimes known as Y-shares, which are even cheaper). The issue with A-shares is that, in most cases, they have up-front sales charges ranging from 4% to 5%, sometimes more. That means if you put $100,000 in, you may only get $95,000 or $96,000 invested. The rest is cut out to the advisor as a commission. If you invest a lot of money, say over $250,000 or over $500,000, you will often qualify for a breakpoint and only have to pay a commission of 2% or maybe even less. However, not all investors are depositing $500,000 at a clip into their funds; they are contributing much less and therefore paying the highest commissions.

B-shares: This is a share class which is quickly becoming outdated. FINRA has notes about B-shares in their investor alerts section* because some investors may purchase class B shares when it would have been more cost effective for these investors to purchase a different share class. B-shares don’t have an up-front sales charge but they have contingent deferred sales charges which mean if you sell the shares before a certain amount of time, often 5-7 years, you will be subject to a fee to redeem the funds. That fee, especially if you redeem funds in the earlier years, can be 3-5%. B-shares are really designed for clients who don’t want to pay an up-front sales charge and won’t touch their funds for several years. This would typically occur in an IRA or retirement account. Even so, if you have a retirement account you want to be careful about using B-shares, especially in the years approaching retirement so that you don’t end up in a situation where you are paying fees to redeem your funds. A quick note on B shares: they convert into A-shares at the end of the CDSC (contingent deferred sales charge) period.

C-shares: These are a popular share class because they are easy for clients and advisors to understand. The ‘hold’ period in which you get charged a fee for redeeming early is only 1-year. Since most people often buy mutual funds with the intention of keeping them for more than 1 year, they often work in terms of not having onerous restrictions on them. Advisors also like them because they get paid an annual trail (commission), often 1%, for any C-shares they keep on their books. The downside with this share class would be keeping them for long periods of time in which A-shares would work out to be cheaper. The upside is that for shorter time horizons, say 3-5 years, the C-share may work out cheaper if you wouldn’t otherwise qualify for a breakpoint (discount on the sales charge).

A note on small business retirement plans: if you own or manage a small or mid-sized business, perhaps with 1-100 employees, the mutual fund share class issue can be an important one. The reason is that you typically won’t qualify for a steeply discounted or institutional share class unless your plan has many millions of dollars in it. The result may be that your advisor or rep encourages you to use C-shares. While these may be marketed as a good option because the sales charge period only lasts 1 year, they actually carry the highest annual expenses and over long periods of time they get very expensive. Because participants in a 401k or IRA plan usually don’t touch the money until they reach age 59 ½, these expenses have many years to drag down the average annual returns of the funds. In the meanwhile, the advisor may be getting a higher-than-necessary fee for assisting you in the share class selection process.

My concluding point here would be that you should be knowledgeable about what you own and what you are buying when it comes to mutual funds. In some large retirement plans, you may get discounted share classes which impose lower fees and perhaps less restrictive holding periods. That’s not to say I love the way 401k plans handle expenses, but that’s a discussion for another day.

As always, feel free to e-mail or call me with any questions or comments.

Russell Bailyn

Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673

Investing in mutual funds involves risk, including possible loss of principal.

Mutual Funds have unique features, benefits and charges, and you should discuss the appropriateness of any investment for your particular situation with a qualified investment representative.  Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. To obtain a prospectus, which contains this and other information about a fund, you may contact your investment representative or call the investment company directly. Please read the prospectus carefully before investing or sending money.

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.
* http://www.finra.org/investors/protectyourself/investoralerts/mutualfunds/p005975

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