Monday, February 9, 2009

Mutual Fund Share Classes

Many investors have no idea what mutual fund share class they are in or why. If you are about to do business with a broker or advisor a little education will go a long way.
There are three main share Classes; A, B, and C. Class Y will represent other share Classes explained later.

Class AClass BClass CClass Y
Managemant Fee.
12b-1 Fee.251.001.000
Total annual Expense Ratio.851.651.70.65

Excluding class Y, you can see from the table above that Class A has the lowest annual expense ratio. The annual expense ratio is the fee taken from the fund each year. It is somewhat of a hidden expense because you never see it come out of your personal account. Instead it is taken from the fund's assets. The net effect to you is a total return minus the expense ratio. So if you own Class A shares and the fund returned 10% the fund company takes .85% and you get 9.15% versus Class B where you would get 8.3%. So why would anybody by Class B or C? Class A carries a 5% or more front end sales load. A front end sales load is taken from the amount you put into the fund. If you contribute $10,000, only $9,500 is invested.

Class B has a back end or contingent deferred sales load. The load is on a declining scale. For example if you sell your shares in the year one or two you pay 5%, year three you pay 4% until the load goes to zero in year 6 or more.

Class C you will only pay the load if you sell the shares within the first year. After the first year the load usually is zero.

Now you are thinking why buy Class A or B. The answer is because of the expense ratio. Class A has the lowest expense ratio and Class C the highest. Over long periods of time Class C becomes the most expensive. The class with the lowest expense ratio will have the highest rate of return. You pay less year after year so you keep more of the return. Eventually the compounding of the higher return makes up for the front end load in Class A. With most companies Class B shares will convert to Class A shares after a number of years and to the lower expense ratio. The Class C shares never get a reduction in expense ratio.

If you are going to hold your shares for 10 or more years more often you are better off with Class A. If you think you are going to hold your shares for 5 years or less, Class C may be your best bet and between 6 and 10 years Class B.

I also put Class Y in the table above. I picked any letter to describe the next set of share classes. Some companies may have one or two more share Classes and other will have several. Most of the other share classes have to do with shares offered in pension plans, 401(k) plans or sold through fee only advisors. They are generally the lowest priced share Class.

The information above is very general including the table. There are many variations to the share Classes by company. For example the spread in the over all expense ratio between the Classes, how long the contingent deferred sales charge is and when and if Class B converts to Class A. The aim here was to give you a general understanding of how share Classes work. I also wanted to point out that what seems like the obvious choice when looking at the sales loads, may not be your best bet when you consider the entire expenses of the fund.

The details about overall expenses can be found in the mutual fund’s prospectus. I encourage everyone at a minimum look at the expense section of the prospectus before you invest.


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