With mutual funds so prevalent in investor’s portfolio today, it is amazing how many are not aware of the differences in share classes. While there are share classes other than, A, B, and C these are the most common, although Class B shares are no longer as common. The different share classes deal with the method of compensation to the advisor, the intended duration of ownership, and the expenses the fund incurs. It was not until the last few years that Financial Industry Regulatory Authority (FINRA) provided guidance as to the appropriateness of each share class.
If managing mutual funds is not your expertise, then using and paying an advisor is the correct choice. If the advisor is a broker, then they will be paid via commissions which are paid by the mutual fund companies. Sadly, I have heard too often investors say they paid no commission and yet they hold either Class B or C shares. While there is no initial deduction for commissions, commissions are being paid in the form of higher annual fund expenses.
Class C shares are designed for short-term holds of at least one year to five years. Since Class C share commissions are part of the fund’s annual expenses and not a separate fee, the amount paid in commissions cumulate for as long as the shares are held. The short holding period recommendation is based upon the following: 1.) typically there is a surrender charge when an investment is sold before one year but none thereafter, 2.) the higher annual expense used to compensate the advisor quarterly never decreases, and once the holding period approaches five years, Class A shares most often would have been more economical, and 3.) the advisor’s commission is built in the annual expense which is usually between 0.75 percent and 1percent higher per year than Class A shares. When funds are redeemed within the one to five year period, then typically only a portion of Class A’s upfront commission has been paid, thus lower expenses were incurred.
While Class C shares work well for investors with short-term horizons, they can be used for longer term holds. Using Class C for long term holds is clearly more expensive than the Class A counterpart but could be beneficial for assets such as emergency funds. Access to these funds may be required in the 2-4 year period and paying a high front load would not be wise. And pulling funds from Class C shares without an exit fee is possible and then can be restored at any time.
Class B shares came on the scene to counter the increasing presence of no-load funds. The marketing often focused on the fact there was no initial deduction for commissions and that all of your money went to work in the market. While this was true, the annual fund expenses are also 0.75 percent to 1 percent higher than Class A shares. It is this higher expense that compensates the advisor. The commission was paid to the advisor at the time of purchase and the higher expense reimbursed the fund for this cost. The general difference between Class B and C shares is the fact Class B shares eventually convert to Class A shares most of the time. This conversion usually occurs around year seven. However, for this class there is a substantial surrender fee usually during the first five years of the holding period which decreases each year until zero. Therefore, these shares are best for longer time horizons, five years or more. Due to high costs of Class B shares, most mutual funds no longer offer this class. Thus, questions should be raised in the event an advisor recommends Class B shares.
The remaining share Class A is best for long-term investors. Class A shares have two features not available to other share classes: Letter of Intent (LOI) and Rights of Accumulation (ROA). These two benefits permit lower commissions or loads on each purchase when qualifications are met.
Today, the fee for the purchase of most Class A shares will range between 5.0 percent and 6.0 percent for equity funds and 4.0 percent and 5.0 percent for bond funds. This is the maximum load before qualifying for discounts. With Class B and C shares costing from 0.75 percent to 1.25 percent more per year than Class A shares, it does not take many years to end up costing more than the Class A shares. And when Class A commission discounts are earned, lowering their initial cost, Class B and C shares will exceed Class A in costs more quickly.
Discounts can be applied when ROA (rights of accumulation) is applied, meaning within one mutual fund family the total value of all funds owned is above one of the discount levels. Total value can include the value of shares owned by a spouse and children within the same fund family. The discount levels usually are the following amounts: $25,000, $50,000, $100,000, $250,000, and one million dollars. Understanding the benefit of each share class will reduce expenses and improve returns.
For assistance with insurance, estate planning, and managing investments, contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com.