Making sense of mutual fund share classes
Q: I’ve noticed that several of my mutual funds have different share classes. I own A shares, but I see that my funds also come in B and C shares. What’s the difference and is one share class better than the others?
A: Many mutual funds offer multiple share classes as a way of repackaging the fees they charge. Let me give you some background and then I’ll give specific information about how share classes differ from each other.
Mutual fund companies charge investors a wide range of fees. When you evaluate a fund, one of your key considerations should be the overall cost of owning the fund. These costs include all sales charges or loads, marketing fees (also known as 12b-1 fees) and management expenses.
John Bogle, the founder of The Vanguard Group, has written extensively about the importance of minimizing fees. His low-fee approach helped him build one of the most successful mutual fund companies in the world. Vanguard now manages more the $5 trillion in assets.
But most mutual fund companies are not in the low fee business. It is not unusual to see sales charges, or loads, in excess of 5 percent. Sometimes loads are paid before you make the investment (called a “front-end” load) and sometimes they are charged when you sell your shares (called a deferred or “back-end” load).
In addition, many funds charge an annual 12b-1 fee to help pay for marketing. 12b-1 fees are usually around 0.25 percent but they can be as high as 1 percent.
Mutual fund investors also pay a fee for the professional management of the fund. Management expenses vary widely. A low-cost index fund may charge as little as 0.05 percent per year while a fund investing in a difficult market sector could charge 2 percent or more.
This is where share classes come in. Mutual fund companies use different share classes to package fees in ways that are more palatable to different types of investors.
A shares, for example, charge a front-end load. Some investors shy away from front-end loads because they seem high. However, A shares often have lower ongoing expenses than B or C shares. In addition, if you invest a lot of money, you may qualify for special discounts on your sales load called breakpoints.
To appeal to investor who don’t like paying front-end loads, mutual funds companies started issuing B shares. B shares charge a back-end load that declines the longer you own the fund. In fact, if you hold the fund 5 to 7 years, you may not pay any load at all. Note, however, that B shares often charge a much higher 12b-1 fee (often 1 percent), so the cost of owning B shares may be higher than owning A shares over the life of the investment. Once you are out of the deferred sale load period, B shares typically convert to A shares.
C shares charge a level load, typically about 1 percent per year for as long as you own the investment. In addition, if you sell you shares within the first year, you may also pay a back-end load. C-shares typically have the highest cost of ownership for a long-term investor.
There are a number of other mutual fund share classes, each with its own permutation of fees and expenses. Before you invest in any mutual fund, regardless of share class, make sure your advisor clearly explains the expense structure of the fund she is recommending. She should also review with you the various share class options and explain why her recommended share class is the best for you.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to email@example.com.