It’s time to develop a little class consciousness.
New classes of mutual-fund shares have sprouted like dandelions in recent years. So here is a crib sheet. Use it to help find the class that makes the most sense for you.
The important thing to remember is that whether a mutual fund share is called A, B, C or something else, you’re getting the same portfolio manager and the same pool of investments. The only difference is the amount you are paying for the privilege.
It’s a choice worth pondering. After all, if somebody offered you a choice of an 8 percent mortgage for 30 years or a 6 percent mortgage for 15 years, you’d grab a scratch pad and do some comparisons, wouldn’t you?
Many investors imagine that there’s a bargain waiting in the newer share classes–the ones that aren’t the standard A shares with the upfront sales charge. Don’t count on it. The newer share classes often are more expensive over time than upfront loads.
Here’s the nitty-gritty.
– A shares. These come with “front-end loads,” so called because you pay a sales charge when you buy them, typically 4 to 5 percent for stock funds. If you fork over $100 to a fund, only $95 or $96 of it gets invested while the rest goes for brokerage commissions. (You won’t see the impact of this upfront load in the annual fund returns.)
A common misconception is that A shares are the most expensive kind. But the one-time sales fee can be less expensive if you hold on to the fund for years. And it is simple. “The front-end load is a heck of a lot easier to understand,” says Barry Barbash, director of the Division of Investment Management at the Securities and Exchange Commission.
– B shares. Think B for “back-end load.” You don’t pay any upfront sales charge, but a load looms when you sell your shares. Such “surrender charges” typically are 5 percent in the first year, declining by one percentage point annually until they reach zero. At that time, the shares revert to A shares, which doesn’t mean anything special. Don’t pity your broker too much. Although you don’t pay an upfront load on B shares, the broker receives a commission from the fund company at the time of sale, and in many cases it’s equivalent to the first-year surrender charge.
– A versus B. B shares were created to take the sting out of upfront loads, but they aren’t necessarily a better deal. True, you avoid surrender costs if you hold on to your fund awhile. But you can’t avoid the annual drag on returns known as the 12(b)-1 fee, named after an arcane SEC rule. It’s another way to compensate brokers–an annual nibble rather than a one-time bite. But it gnaws hardest at the B shares: These tend to have higher 12(b)-1 fees of around 1 percent annually, against maybe 0.25 percent for A shares.
That’s a major reason why the annual returns you’ll find in a newspaper are higher for A shares than for B shares of the same fund. When a newspaper reports a return, it has already subtracted the annual expenses, including 12(b)-1s.
– C shares. These were created for “mutual-fund wraps,” the popular programs in which advisers charge you an annual fee based upon how much money you have. There’s no upfront load at the time of sale. (You do pay a surrender fee of 1 percent if you sell your shares in the first year.)
But the more notable costs here aren’t so obvious. The fund company is paying the financial planner or other adviser 1 percent at the time of sale, and very often a 1 percent trailing commission annually. To help cover these costs, your C shares come with higher-than-usual 12b-1 fees (often 1 percent annually) and these, in turn, boost your annual fund expenses.
And don’t forget: You’re paying your adviser the separate asset-based fee, often an additional 1 percent a year beyond any fund expenses. Whether you’re using a broker, financial planner or adviser, if you are getting advice, you are paying for it somehow.
– Load-waived A shares. These are quirky versions of A shares that most load-fund companies have recently whipped out to be sold by brokers and advisers who charge an annual fee.
Load-waived doesn’t mean no-load. As a general rule of thumb, whenever you hear the term load-waived, you’ll find higher annual expenses each year than no-load funds or A shares. Once again there is no free lunch.
– Cutting costs. If you’re trying to stick with only the less expensive share classes, one way to do so is to use fee-only advisers, including members of the National Association of Personal Financial Advisers, whose members don’t accept commissions of any kind. (They won’t even choose share classes that pay them “trails.”)
Or, you could, by yourself or with an adviser, use Charles Schwab’s OneSource program, which bans the more expensive share classes. Advisers using OneSource cannot receive any compensation other than the annual fee you pay them.
If your adviser uses a supermarket program that allows a gaggle of share classes, ask the adviser to use only the cheapest classes, or to offset his annual fee to make up for the difference. If the adviser’s annual fee is 1.5 percent, and he’s receiving a 0.25 percent annual “trailing commission” from the mutual fund company, ask him to reduce his fee to 1.25 percent. “The better ones will do that,” says Berton Seltzberg, a fund consultant in Philadelphia.
– Hybrid loads. This is a grab bag of share classes including things called Class 2, Class D and other designer labels. There’s no telling what you might find. Merrill Lynch introduced Class D shares of some of its funds in 1994; they have upfront sales loads, and an annual 12b-1 fee of 0.25 percent. The expense results in lower returns for the Class D shares than for the Class A shares.
– I shares. Last year, Fidelity introduced Class I (as in “institutional”) for its Adviser funds. These have no loads or 12b-1 fees, but financial advisers and brokers must charge clients an asset-based fee of at least 0.50 percent a year.
– No-load. These have no sales charges. Investors buy them directly from the mutual fund companies, or their advisers choose them for “wrap” portfolios on which the advisers charge a separate annual fee. No-loads pay no commissions of any kind, including hard-to-see “trail fees.” Technically, no-loads have no class. Brokers say they offer investors no help. But they also present no alphabet soup to consider.
