The ABCs Of Mutual Fund Share Classes
Originally published on Nov. 19, 2014 You don’t need to read a prospectus to benefit from knowing the basics about mutual fund share classes. It will help you uncover your actual investing costs (especially when dealing with a broker), avoid unnecessary fees, and boost long-term performance. As you will see, even after you select a fund, it is crucial that you choose the most appropriate share class of that fund. Bringing Funds to the Marketplace Just like a farmer needs to get their crops to market, mutual fund companies work through multiple distribution channels to sell their products. These could include direct sales via online brokerages, sales to pension plans, through a broker, a registered investment advisor, and so forth. Each of these channels has different end clients and associated costs; and because of this, companies have developed different versions (share classes) of the same mutual fund to suit each situation. Typical Mutual Fund Fees Annual Expense Ratio – The ongoing fee to manage and administer the fund. Most investors will never notice this cost since it’s a tiny fraction taken from the share price (NAV) each day. Trading fee – A fee charged by the executing brokerage company/custodian, typically $0 to $50 per buy or sell order. Front-end Load – A sales charge applied when a fund is bought; it typically declines for larger purchase amounts. Back-end Load – A sales charge applied when a fund is sold; it typically declines over several years. Fund Share Classes with an Example “A” shares have a front-end load. “B” shares have a back-end load, but have a lower expense ratio if held long enough. “C” shares have no load after a short time, but have a higher expense ratio. Other shares such as “D” or “Institutional” exist. These shares typically have no load, but may have limited availability. The well-known Pimco Total Return Fund (MUTF: PTRAX ) provides a great illustration of how one mutual fund offers many different share classes of the same fund. Broker Assisted Investors After considering the overall costs from the table above, you will see where the costs are built into the mutual fund structure and sales channels. Brokers are typically compensated by the A, B, or C share classes, but also can get residual compensation via fees built into the mutual fund expense ratio (e.g. 12b-1 fees). Remember, brokers do not have a legal obligation to put you in the “right” share class. So if you are using a broker, be sure to give them more information on how you plan to invest or you could end up paying them larger fees than you should. With a broker for example, if you knew you were going to buy $10,000 of the Pimco Total Return fund, but sell it within 3 years, you will probably be better off with the “C” shares. However, if you have no idea how long you will hold the fund, the “B” shares may be a better bet – since the costs to own will decrease over time. If you had a substantial amount to invest for a long time, the “A” shares may ultimately be the cheapest option even though you are paying the 3.75% front-end load. Advisor Clients Registered Investment Advisors like us typically have “Institutional” share classes available to them. At our firm, we pay close attention to fund expenses and transactions costs for our clients. Because of this, we will frequently use more than one share class of the same fund, or two slightly different funds in the same asset class – all in order to minimize the long-term costs for our clients. It is certainly more complex to juggle the various share classes in a portfolio, but we believe you can use them to your distinct advantage.