Mutual funds are among the most widely used investment vehicles for long-term financial goals, such as retirement and college planning. Because they are such a popular investment, it is important to understand how you pay for them, as the cost can have a profound impact on your return over time.
One of the easiest ways to determine how you paid for your mutual funds is by the share class. You can find this information rather easily by reviewing your most recent account statement. At the end of the name of the investment will be a letter – most often A, B, or C.
If you own Class A shares, that means you paid an up-front sales “load” when you initially purchased them. These charges can be as high as 8.5 percent, though it is uncommon that mutual fund companies charge the maximum allowed commission. Instead, most mutual funds cost 5.75 percent or less of the initial investment.
Class A shares recognize a benefit not available to other share classes. When investors purchase these shares, they can qualify for breakpoints, or volume discounts, for their investment. Some mutual fund breakpoints start as low as $25,000, and investors can often realize these discounts if they agree to a letter of intent. With a letter of intent, investors commit to invest enough money over a specified period of time in order to qualify for the reduced sales charge on each dollar invested. Since the terms vary by mutual fund company, you should refer to your prospectus to determine the terms of your investment.
To demonstrate the significance of breakpoints, consider XYZ mutual fund that has a breakpoint at $100,000. Suppose you have $95,000 to invest today. To invest $95,000, you will incur a 4.5 percent sales load, for a total cost of $4,275. This fee will be split between your financial adviser, the broker-dealer and the mutual fund company. The remaining $90,725 is invested to buy shares of XYZ mutual fund.
However, if you could invest an additional $5,000 over the next year to make your total investment $100,000, then your investment cost would decrease to 3.5 percent, or $3,500. Breakpoints reduce investment costs and allow investors to put more of their money to work. As a word of caution, always be mindful of your breakpoint thresholds if you are working with a commissioned salesperson. There are some unscrupulous advisers who will not inform you that you are approaching a breakpoint, as it could reduce their income.
Unlike Class A shares, Class B and C shares have a deferred, or back-end, sales load. This means that there is no cost to initially invest in the mutual fund. However, if you sell the shares within a certain time period, you will incur a sales charge at the point of sale. The Class B shares sales charge usually decreases by 1 percentage point annually until there is no cost to sell the shares. At that time, mutual fund companies sometimes convert those shares to Class A shares. Class C shares, however, have a shorter surrender schedule that is usually limited to one year. After that period, you can sell the mutual fund without incurring a sales charge.
Finally, investors can own mutual funds without incurring any sales charge. These funds are commonly referred to as “no-load” mutual funds, and just as the name suggests, there is no sales cost for purchasing or selling the shares. Historically, these mutual funds were more widely used by the do-it-yourself investors. In recent years, however, more advisers have recommended these investments to their clients via investment advisory accounts.
In my next column, I will explain ongoing fees for mutual funds. Regardless of which mutual fund option you choose, each has its benefits and drawbacks. Nevertheless, understanding all the fees associated with your investment is important because it’s not what you make that matters, it’s what you keep.
Life’s a journey; plan for it.
Ashleigh Brooker, CFP, is the principal of A.J. Brooker Financial Associates in Columbia. Reach her at info@AJBrooker.com or (803) 724-1235.