It helps to know the ABCs of different fund classes

Your Funds

Your Money

October 09, 2005|By CHARLES JAFFE

Maureen R. in Holland, Pa., thought she was doing the right thing when she established brokerage accounts for her four children and put the money into the Class C shares of a mutual fund.

Now she's not so sure.

Maureen met with a different financial adviser, who suggested that the accounts for the children - ages 6 to 13 - should be in Class A shares, and that the first adviser had made a mistake.

Two advisers with two opinions create one confused customer.

Funds come in different classes so that investors have choices in how they compensate their financial advisers. There is no difference in the holdings of XYZ Growth A and XYZ Growth C, but the fee and expense structures are different, and picking the wrong fund type can be a costly mistake.

Before you can see how C shares could be right or wrong for Maureen, here's a primer on the ABCs of mutual funds.

A is for "all at once." With Class A shares, the investor pays a traditional front-end sales load, usually lopping 3 percent to 6 percent off the top to pay for the services of the adviser. A shares carry the lowest continuous costs, which tends to make them the best option for long-term investors.

Morgan Stanley Aggressive Growth A has a front-end charge of 5.25 percent, and a total expense ratio of 1.37 percent.

B stands for "back-end." Class B issues carry a load payable if you exit within a set period, usually the first four to six years. They also carry a higher expense ratio, although most convert to lower cost A shares when the redemption period expires.

Morgan Stanley Aggressive Growth B, for example, has no front-end load, but carries an expense ratio of 2.13 percent, and has a deferred sales charge that maxes out at 5 percent.

C stands for "Chuck hates them," but I confess that's because I take a long-term perspective on buying funds. Class C shares have no upfront sales charge but may have a small deferred load if you sell the fund in the first year or two. In exchange for the reduced sales fees, the fund carries higher costs for life.

Morgan Stanley Aggressive Growth C, for example, has a 1 percent deferred charge to protect the company against quick-turnarounds, but the fund carries an expense ratio of 2.12 percent, which - unlike the B share - never goes down.

As a general rule, C shares tend to be the best choice for an investor who doesn't expect to stick around too long.

Using the mutual fund cost calculator of the Securities and Exchange Commission - and available free at www.sec.gov - a comparison of costs shows why Maureen is confused.

Say someone invested $10,000 today and expected to leave the money in place for a decade, getting an 8 percent return. The cost of investing in Morgan Stanley Aggressive Growth A - the sum of all fees paid, plus any earnings surrendered by paying sales charges - is $3,769. At the end of 10 years, the investor would come away with $17,819.

By comparison, the same investor putting the money into the same fund's C class would have paid $4,164 in total costs and would come away with $17,425. Drop the holding period down to five years or less, and the C shares come away with a slight edge.

So if Maureen is expecting to hold a fund for more than about five years, the A share class would best. If the holding period is beneath that, another class may be better.

jaffe@marketwatch.com

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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