If you buy mutual fund shares from a broker, financial planner, insurance agent or a fund's own sales force, you may have to choose between a fund with a front-end sales load and one with a back-end load.
Should you pay a fee that can run as high as 8.5 percent when you buy shares (depending on the fund and size of your investment)? Or should you pay a fee that can run to 5 percent or more (depending on the fund and the length of time you owned the shares) when you redeem them?
Your choice isn't only between paying now and paying later. You're also choosing the level of the annual 12b-1 fee that you'd accept to help compensate the people who sell a fund's shares, and other distribution expenses. Named after SEC Rule 12b-1, the fees are usually higher for funds with back-end sales loads and can absorb as much as 1.25 percent of a fund's net assets every year.
As if weighing all of this when looking for suitable funds isn't
tough enough, it's going to get tougher.
More and more, you'll be comparing loads and fees, not only among different funds, but also between two -- and, before long, among even three -- classes of shares of the same funds. Class A shares usually involve front-end loads and low or no 12b-1 fees; Class B shares, back-end loads and high 12b-1 fees.
Because the methods and levels of payments to people in the distribution chain vary, your prospective yields and total returns vary also. Therefore, you need to study them closely before choosing.
Merrill Lynch introduced "dual pricing" with 22 of its funds in October 1988, two months after the SEC allowed it to do so.
"We had funds with front-end loads and funds with deferred charges," Gregg Durett, a vice president, recalls. "It seemed like we were going to have two fund families."
The firm decided to offer B shares for stock and bond funds that had conventional front-end loads and to offer A shares for funds with back-end loads. Today, nearly all of its 41
funds have two classes.
Other firms -- led by Alliance, PaineWebber and Prudential -- began to offer two classes also. More companies are expected to join them.
That's not surprising, considering the benefits that companies can receive by enhancing brokers' incentives to sell fund shares.
Patterns vary among firms.
Merrill Lynch, for example, levies a 6.5 percent load for the A shares of equity funds and a 4 percent load for the A shares of most of its bond funds but, usually, no 12b-1 fees. Most of its B shares carry 4 percent loads and 12b-1 fees ranging from 0.75 to 1 percent. Others have lower loads for some A shares, higher loads for some B shares, and 12b-1 fees for both. Back-end loads generally disappear in three to six years.
What form would an additional class take? That remains to be seen. PaineWebber, for one, has requested SEC authorization to offer a class without loads but with 1 percent 12b-1 fees, said Joyce N. Fensterstock, president of the firm's fund group.
To see how your choice of a share class could affect you, look at the table, which is based on a hypothetical bond fund.
You'll note that, if you'd buy A shares, $9,700 of a $10,000 investment would be at work, and your yield, based on the $10,000 you put down, would be 7.7 percent. (A no-load fund, earning the same 9 percent income and having total expenses of 1 percent, would yield 8 percent.) Whenever you wanted to redeem, you'd get the $9,700 back.
By going for B shares, you'd have all of your $10,000 at work, but the higher 12b-1 fee would cut your yield to 7 percent. When redeeming, you'd lose money until you've held the shares three years.
Clearly, the 12b-1 fee's impact on income makes B shares less attractive when yields are lower and expenses account for a larger share of investment income. (Some fund companies don't offer B shares in lower-yielding municipal bond funds.)
For equity funds, dual pricing is another story. Since investment income is even lower, 12b-1 fees take an even larger bite out of B shares' yields. But, given that equity funds should appreciate over time, the costs may be less onerous.
When considering a fund with two classes, two points are especially important: How much you're investing and how long you're going to hold onto the shares.
If you plan to invest a large sum, entitling you to a front-end load well below a fund's maximum, A shares could be significantly more attractive.
If you intend to remain invested for a long time, A shares also could be preferable because several years of 12b-1 fees could exceed the front-end load.
Funds with two classes of shares
(A hypothetical example)
.. .. .. .. .. .. .. .. .. .. ..Class A Shares.. .. ..Class B Shares
.. .. .. .. .. .. .. .. .. (3% front-end load).. .(3% back-end load)
Initial investment.. .. .. .. .. .. .. $10,000.. .. .. .. .. $10,000
Less: sales load.. .. .. .. .. .. .. .. .(300).. .. .. .. .. ..-----
Money at work.. .. .. .. .. .. .. .. .. .9,700.. .. .. .. .. .10,000
What you would receive yearly in income dividends: