The A,B,Cs of Mutual Fund Investing
A Mutual fund is a company that will pool money from investors and manage the assets according to its stated investment strategy. For years mutual funds have been an easy way to invest in a diversified portfolio of securities. Because of this feature, investment brokers will use them to help a client obtain diversification without having to make individual security selections. The investment selection is left up to the fund manager. With over 10,000 mutual funds to choose from, fund selection can be a tedious process. Whenever making an investment decision, it is always prudent to consider the cost associated with making the investment. Over the long-term, mutual fund expenses can play an important role in the overall performance of a portfolio.
Mutual funds are generally classified as “no-load” or “load”. A “load” is a commission that the investor pays to purchase a fund. The commission is used to compensate the brokerage firm and the broker that sells the fund. “No-load” funds do not have a commission and will rely on advertising or performance to attract investors. “Load” funds usually offer more than one class of shares (e.g. Class A, B or C). Each class will have different fee and expense charges, thus each will likely have slightly different returns.
Class A shares usually have an upfront “load” or commission. This load can range from 2% to 5.5%. This front-end “load” is taken off the top, so a $1,000 purchase of a fund that has a 5.5% load will result in $55 taken off the top; therefore, $945 is actually invested. In addition to the load, each fund manager will charge shareholders a percentage for managing the fund, typically between .10% and 2.00%. This management expense along with other annual charges makes up the total operating expense. The total operating expense ratio can usually be found very easily on the internet or by reading the fund prospectus. The higher this expense, the greater the impact over the long-term on your returns. For example, if you invest $1,000 in Fund ABC that has a load of 4.5% and has total annual operating expenses of 1.0%, your first year fee will be approximately $54.55 (($1,000 x 4.5%) + (955 x 1.00%)). In subsequent years, the annual fee will be 1.00% of the assets invested.
Class B shares do not have a front-end load; instead the load is charged when you sell the fund. This is referred to as a “back-end” load. The amount of the load will decrease over a period of years and eventually be zero if held long enough, typically 7 years. In addition to the annual management fee, a “12b-1” fee may be imposed to offset the commission paid to the broker who sold the fund or for other market and advertising expenses. Because of the extra 12b-1 fees, the total annual operating expense for Class B shares will usually be higher than Class A shares. Class B shares may be converted to Class A once the holding period is met.
Class C shares will have a lower front-end or back-end load, if any at all. These shares are often referred to as “no-load”; however, the total annual expense ratio is usually higher than Class A or B shares. With a higher expense ratio, the returns on this class of shares will usually lag the other classes.
Which class of shares is the most cost efficient will depend on how long the fund is held. The shorter the holding period, the more likely Class C shares will be the most cost efficient. However, if the holding period exceeds 3 or 4 years, Class A or B shares begin to make more economical sense. When making a decision on share classes, the Securities and Exchange Commission website http://www.sec.gov/investor/tools.shtml offers an analysis tool to determine the most cost efficient choice. In addition, more information on investing in mutual funds can be found at http://www.sec.gov/investor/pubs_subject.shtml#mutualfunds
At Crescent Sterling Ltd, we believe investors should be educated about the products and services available to them. As a fee-based advisor, we offer unbiased investment guidance to help clients reach their goals.