Buying the right mutual fund share class can save you money

This has been a topic in the past and while it may not be new, there are thousands of shareholders still purchasing the wrong mutual fund share class. The impact is lower performance for the investor and generally higher commissions to the registered representative or broker. If you do not think you could not be involved, you might double check your accounts.

On February 28, the Financial Industry Regulatory Authority (FINRA) released a statement they were settling with five brokerage firms regarding improper mutual fund sales to 5,300 households. The primary violations were the improper sales of Class B and Class C shares to individuals and failure to have supervisory systems designed to provide all eligible investors with the opportunity to purchase Class A shares at net asset value (NAV) through NAV transfer programs.

In this case, Merrill Lynch, Prudential Securities, Pruco, and UBS were fined a total of $2.4 million. Wells Fargo, also involved, avoided fines, since they had already taken steps to correct the problem. In addition to the fines, these firms are returning to investors millions of dollars in excess fees and per FINRA, this may exceed $25 million. The regulatory agency reviewed the 2001 through 2004 period and discovered investors paid new Class A fees even though the mutual fund company offered Class A shares at NAV, if the investor were purchasing shares with proceeds from the redemption of other mutual funds which they had paid a commission. Other investors had been directed to Class B or Class C shares improperly.

While most brokers are trustworthy, clearly there are some brokers looking out for their own interests and not that of their clients. The following recaps the proper use of Class A, B, and C mutual fund shares.

Starting with Class B shares, this class of shares should be purchased by the fewest number of investors, and many mutual fund companies no longer offer this share class due to high expenses. Originally, investors were permitted to purchase up to $250,000 of this share class, but the limit was reduced to $50,000 by most fund companies if the class is offered at all. There is no up-front fee for this share class, which makes them attractive to investors, however; the management fees are higher by almost 1 percent, and there is a declining redemption fee if sold in the first five to seven years. Only long-term investors and generally those who are unable to invest more than $50,000 over several years should consider this share class. Since the shares convert to Class A at the end of the surrender period, you might wonder what the benefit was of purchasing Class B shares. The answer is none. By purchasing Class B and not Class A, they generally paid higher annual fees over the holding period, and this is why FINRA has handed out fines. If you have the ability to invest more than $50,000 over time, then Class A shares most likely will be less costly.

Class C shares are designed for the investor with a shorter time horizon. While this share class also has higher annual management fees, the surrender charge on this share class is generally over at the end of the first year. Unlike Class B shares, at the end of the surrender fee period the shares do not convert to Class A shares. For the investor expecting to sell their investment at least a year in the future, but most likely not longer than four or five years, then purchasing Class C shares will result in lower fees. Because there are no acquisition fees or surrender fees after one year, the higher annual fees are only incurred during the holding period which for a short investment time frame should result in lower fees. But, since this share class never converts to Class A shares which have lower annual fees, holding this share class for periods longer than five years makes them more costly to own than Class A shares. As such, they are never suited for retirement accounts, unless the shares are planning to be redeemed within four or five years.

If Class B and Class C shares do not fit your objective, then Class A should be the ideal share class for you. While you pay an up-front fee, the lower annual fees will make up for the acquisition costs provided the shares are held for four or more years. Many investors are put off by seeing their investment value drop by the up-front fees of Class A shares, hence why many investors fall prey to purchasing Class B or Class C shares inappropriately. The upfront fee not only compensates the broker for their expertise in selecting funds, but also to continue to service and manage your investment.

While there are brokerage firms as well as brokers being fined for inappropriate action, venturing into investment management alone is not the best solution for most individuals. Qualified representatives who manage their clients’ assets will over time prove their worth in the services they provide. If you are unclear as to whom you should trust, first seek those brokers who have taken the time to obtain the CFP or ChFC credentials.

© 2008 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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