When buying mutual funds, I always used to buy Class B shares or Class C shares, the type that do not levy an upfront sales charge. These always seemed to make more sense to me; they looked like the cheaper way to go.
Then my financial adviser opened my eyes. He explained why Class A shares, which require an upfront sales fee, often are cheaper to own than Class B shares or Class C shares. I think your readers should know what I just learned. Can you please relay this message?
- B.S., Titusville, Fla.
With so many variables, it's impossible to say that one particular share class always has a clear-cut cost advantage over another.
We only know the following:
Class A shares often charge upfront fees but generally have the lowest annual operating expenses among the three common share classes.
Class B shares charge no upfront sales fees but often slap you with a redemption fee if you sell the fund within five years. That fee often, but not always, declines by a full percentage point with each passing year, until it dwindles to zero starting in years five or six.
Class C shares charge no upfront sales fees and no back-end sales fees. But they usually have the highest operating expenses, or expense ratios, of the three share classes.
The basic working parts of share classes A, B and C can tell you a lot. But they cannot, by themselves, tell you which share class would be cheapest for you to own.
To accurately measure a mutual fund's purchase and holding costs, you must factor in the following:
The fee structure for each share class in the fund you plan to buy or already hold.
How much you plan to invest; how long you plan to hold the fund, and your expected annual returns.
"You have to look at each mutual fund and each share class on an individual basis and compare the costs of ownership for each," said Reuben Gregg Brewer, editor of Value Line Mutual Funds newsletter.
To make such cost comparisons, you need a copy of your fund's prospectus. Then you can go to a mutual fund cost calculator on the Securities and Exchange Commission's Web site: www.sec.gov/investor/tools.shtml.
The key bits of data to pull from your fund's prospectus would include upfront sales charges, expense ratios, back-end sales charges and redemption fees. You should also find out if your Class B shares would convert to Class A shares if held for a certain period - most often seven years.
The calculator also asks you to make assumptions about your expected annual returns. Try 7 percent to 10 percent a year for a stock fund; 4 percent to 7 percent a year for a bond fund; 1 percent to 4 percent annually for a money market fund.
The SEC calculator also asks how long you plan to hold this particular investment. Think carefully.
"If you're looking at a fund that invests in one industry, your expected holding period might be just two to three years. If you're looking at a broad stock index fund in a retirement plan, you might plan to stay with the fund for 20 years," Brewer said.
As a general rule, Class A shares favor buy-and-hold investors plunking down large sums of cash at once. The downward sliding commission scale, and relatively low operating costs, help reduce the purchase and holding costs for well-heeled buyers and holders of Class A shares.
Class C shares are often most suitable for investors expecting a relatively short holding term: three years or less. The elimination of front-end or back-end commissions easily cancels out the relatively high expense ratios - just so long as you stay in for the short term.
Class B shares can work well for investors giving a high-risk investment a test run. If the investment rises in value, this investor would presumably be glad to pay a higher nominal back-end commission to sell the holding at a gain.
If, on the other hand, the value of a $10,000 investment falls to $8,000, a nominal fee of 5 percent would decline along with the value of the investment - from $500 on a value of $10,000 to $400 on an investment sold at $8,000. In this case, the Class B holding is superior to Class A.
Matthew Lubanko is a columnist for The Hartford Courant, a Tribune Publishing newspaper. E-mail him at email@example.com.