The ABCs of Mutual Fund Class Shares

The ABCs of Mutual Fund Class Shares

Class A shares typically feature an upfront sales charge or "load," which is a percentage deducted from each initial investment amount. This load compensates brokers or financial professionals recommending the purchase. Additionally, Class A shares often charge lower ongoing expenses making them an attractive option for long-term investors seeking to minimize costs. Class A shares also offer advantages not shared by other share classes, including breakpoints and letters of intent (LOIs) which we will discuss later on in more detail. In general, A shares are best for long-term investors of more than five years. Each fund’s specifics will vary, so you must properly analyze the fund taking into consideration the client’s unique circumstances and financial objectives. Even with a front-end load, the internal expenses of Class A share funds are typically lower than those of Class B and C shares, and the lower fees can have a significant positive impact over time. In some instances, the fund will waive the front-end sales charge but charge a short-term redemption charge, so be sure that you understand where this applies. Generally, this applies for large dollar purchases or for some income funds.

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The ABCs of Mutual Fund Class Shares

Many fund companies no longer offer Class B shares. Still, you may encounter clients who already hold Class B shares of a mutual fund and must understand this information prior to recommending a redemption or an exchange. Instead of an upfront sales charge, Class B shares typically operate with a back-end sales charge, known as a contingent deferred sales charge (CDSC), imposed upon redemption within a specified period, often five to seven years. In addition, Class B shares frequently have higher ongoing expenses (12b-1 fees). You should exercise careful due diligence before recommending a redemption or exchange from a B share.

The ABCs of Mutual Fund Class Shares

Class C shares typically do not impose an upfront sales charge, allowing investors to purchase shares of the fund without initial costs. However, they may feature a contingent deferred sales charge (CDSC) if shares are redeemed within a short timeframe, often one year. Additionally, Class C shares typically have higher ongoing expenses (12b-1 fees) compared to Class A shares, potentially impacting long-term returns. While Class C shares may be appealing for short-term investors, the higher ongoing expenses can erode long-term returns, even if those expenses are relatively low. The ideal window for a Class C share, from an expense standpoint, is generally between a 1-3 year time horizon. You must provide a copy of the FINRA Fund Analyzer comparison when selling Class C shares. Additionally, you must exercise careful due diligence to make sure the time horizon is appropriate.

You should make sure that you read the fund prospectus carefully to understand the sales charge, as not all fund companies charge the same percentage sales charge for all funds. Sometimes income or municipal funds have lower sales charges than equity funds, and money markets typically do not have a sales charge. Class A shares offer several breakpoints, which are investment thresholds at which the sales load can be reduced. Most funds typically have their first breakpoint at $25,000 or $50,000. As a hypothetical example of a generic mutual fund, if a client were to invest $50,000 all at once into an A share fund, instead of paying a 5.5% load, they might instead pay only a 4.5% load. Investors can meet breakpoints to reduce fees in several ways, including making a larger one-time purchase. Some funds will allow a customer who is anticipating investing an amount that would qualify for a breakpoint to submit a letter of intent (LOI), committing to that level of investment within a specified time (usually 13 months), even if they don't have the funds available to invest all at once. The client will receive an immediate sales charge reduction. If the customer does not fulfill the terms of the LOI, the mutual fund will adjust the account to retroactively charge the difference between the breakpoint discounted fee and the higher fee they would have otherwise paid. This can be useful to customers who anticipate investing a larger sum over a period of time, such as when rolling over from several different retirement accounts into a mutual fund account. Another feature of mutual funds which enables clients to achieve fee discounts is called rights of accumulation. Rights of accumulation permit customers to combine various accounts they have within a single fund family and aggregate the combined amount to qualify for breakpoint discounts. Many funds will also permit aggregating funds held by other members of the household, such as a spouse. Please refer to the fund prospectus for details. Remember that you must act in your customer’s best interest, which includes exploring ways to reduce fees. You must not recommend allocating among several fund families to avoid breakpoints. Make sure to inquire whether your client or someone in their household already owns shares of a fund family you are recommending, so that your client can take advantage of all rights of accumulation. Be sure to ask about funds in retirement accounts as well.