Mutual Funds – Knowledge is Power
The mutual fund business is a massive business. At the end of the year 2016, there were 16.3 trillion dollars in US mutual funds. Retail investors (i.e., households) held the vast majority (89 percent) of the $16.3 trillion in US mutual fund assets.
Although mutual funds are, generally speaking, are a relatively unsophisticated investment, they can still be very difficult to understand for the average person or investor. The different share classes offered by various funds alone can be confusing to an inexperienced investor.
For the most part, the only difference between each share class is the cost to the investor and the compensation to the broker. This, however, creates a confusing and sometimes misleading landscape for the investor.
Let’s go through the more common share classes of funds and outline what differentiates them from one another.
Class A Shares
Typically carry an up-front fee (load) to buy into the fund. These loads can be as high as 5.75%. In addition, Class A shares may impose an asset-based sales charge (often 0.25 percent per year), but it generally is lower than the charge imposed by the other classes (often 1 percent per year for B and C shares).
Class B Shares
Class B shares typically do not charge a front-end sales charge, but they do impose asset-based sales charges that may be higher than those that you would pay if you purchased Class A shares. Class B shares also normally impose a penalty, known as a contingent deferred sales charge (CDSC), which you would pay if you sell your shares within a certain period, often six years. For this reason, these shares should not be referred to as “no-load” shares. The CDSC normally declines the longer you hold your shares and, eventually, is eliminated. Within two years after the CDSC is eliminated, Class B shares often “convert” into lower-cost Class A shares. When they convert, they begin to charge the same fees as Class A shares.
Class C Shares
Class C shares do not impose a front-end sales charge on the purchase, so the full dollar amount that you pay is invested. Often Class C shares impose a small charge (often 1 percent) if you sell your shares within a short time, usually one year. They typically impose a higher management fee than Class A shares and, since they generally do not convert into Class A shares, those fees will not be reduced over time. Additionally, in most cases, your total cost would be higher than with Class A shares, and even Class B shares, if you hold for a long time.
Class D Shares and Class F Shares
Class D and Class F Shares are usually no-load mutual funds. While no-load mutual funds do not charge “commissions” upon their purchase, there are ongoing expenses that are assessed to investors. These ongoing expenses vary for each fund. Class D and Class F share funds can be purchased at most discount brokerage firms through their “mutual fund supermarket” platforms. Many D and F share class funds pay an annual 12b-1 fee to the brokerage firm (not the advisor that may recommend the fund. No-load funds are often referred to as “investor shares” and do not always have a formal share class title. Therefore you won’t often find a letter, such as A, B, C, or I, at the end of the mutual fund name.
Class I Shares
Institutional shares, often labeled as “Inst” funds, Class I, Class X, Class Y, or Class Z, are generally only available to large (institutional) investors with minimum investment amounts of $25,000 or more. In general, institutional class mutual funds are better than other share classes because the lower expense ratios translate into higher returns for the investors because the fund is not withholding as much money for the purpose of paying the operating costs of the mutual fund.
Well, by now, you probably have a headache. My apologies if that’s that case. However, knowledge is power, and education is important. Mutual funds can be a good investment vehicle for a beginning investor, particularly if he/she does not have a large amount of capital to invest.
If, however, you have significant assets, a mutual fund may not be your best option. It’s possible to achieve adequate diversification and reduce fees with a portfolio of individual securities and or exchange traded funds. I will discuss these other options in greater detail in the next issue.
The author, Stephen P. O’Donnell Sr., is President of O’Donnell Wealth Management, a financial planning and asset management firm located at 1306 Sheridan Avenue in beautiful Cody, Wyoming. Steve has 18 years of experience, having worked as a portfolio manager for some of the largest firms on Wall Street. For a no cost, no obligation, initial consultation, call 307-586-4279, email, or simply stop by the office Monday through Friday.
Investment Advisory Services Offered Through Saxony Capital Management, LLC. Securities Offered Through Saxony Securities, Inc. Member FINRA/SIPC.
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