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Mutual Funds – Know Your ABCs

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The mutual fund companies in many cases do nothing to make selecting or understanding their funds easy.  One area of potential confusion for investors is (in some cases) the myriad of share classes available among the same fund.

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Under the broker-sold model, the basic share classes are A, B, and C.  Using the American Funds Washington Mutual Fund, a Large Cap Value fund, as an example here is a comparison of the returns and expenses by share class:

A – AWSHX B – WSHBX C – WSHCX
3 yr return 15.66% 14.79% 14.72%
5 yr return 1.21% 0.44% 0.40%
10 yr return 6.11% 5.31% 5.25%
Expense ratio 0.62% 1.38% 1.42%
Front Load 5.75% NA NA
Max Def Load NA 5.00% (6 yrs) 1.00% (1 yr)
12b-1 fee NA 1.00% 1.00%

Source:  Morningstar

All three share classes are sold by commissioned based and fee-based advisors.

  • The A shares are the cheapest to own over time; however investors pay an upfront charge of 5.75%.  For every $10,000 invested, $9,425 actually goes to work for you with the rest going to the broker.  Typically there is no load for purchases above a certain dollar level and subject to some restrictions exchanges between other funds in the same family will not incur a sales load.
  • The B shares are no longer sold by the American Funds and many other fund companies.  While there is no front-end load, the deferred sales charge starts at 5% in the first year, drops to 1% by year 6, and disappears in year 7.  This means that there is a back-end sales load if you sell in the first 6 years.  In addition, the 12b-1 charge which is part of the expense ratio makes the fund more expensive to own each year.  This fee goes to compensate the broker in lieu of the front-end load.
  • The C shares have a level load in the form of a 1% 12b-1 fee that never goes away.  In addition there is a back-end load in the form of a 1% deferred sales charge for the first year.  With both the B and C shares, there is typically no additional charge for transferring to another fund in the same family and share class, though this could trigger a taxable situation if there is a gain and the fund is held in a taxable account.

Beyond the load world, there are still a number of share class options to consider:

  • A number of fund companies offer separate retirement share classes for use in 401(k) plans.  The most robust menu of retirement plan share classes belongs to the American Funds.  Continuing with the American Funds Washington Mutual example, there are 6 retirement plan share classes with the following expense ratios:
    • R1 – 1.40%
    • R2 – 1.39%
    • R3 – 0.96%
    • R4 – 0.65%
    • R5 – 0.35%
    • R6 – 0.31%

These lower expenses fall right to your “bottom line” in the form of higher returns to shareholders.  If your plan contains funds in what appear to be a higher cost retirement share class (whether via the American Funds or other fund families) this might be a reason to question those who are responsible for running your company’s plan.  The fund expense disclosures that you have likely received by now for your company retirement plan are a great starting point to review the expenses of all investment options offered by the plan.

  • Even low cost provider Vanguard has different share classes for some of their funds; generally the more advantageous share classes have a higher minimum investment than their base Investor share class.  Using the Index 500 Fund as an example, the Investor share class has a low expense ratio of 0.17%.  However, if you have $10,000 invested in this fund you will have access to the Admiral share class with an ultra-low expense ratio of 0.05%.  In some situations the next level fund for investors might be the Signal share class with an identical expense ratio.  If you hold the Investor share class check with your custodian to see which share class you are eligible for.  Typically if you invest directly with Vanguard they will notify you automatically if you are eligible for the Admiral shares.
  • One of the advantages that I am able to offer my clients is access to more advantageous share classes than they could generally get on their own.  One example is the PIMco Total Return bond fund.  The D share class is no-load with a $1,000 minimum investment.  This share class carries an expense ratio of 0.75%.  I have access via Schwab to the Institutional share class of the fund, which usually carries a $1 million minimum investment and a much lower expense ratio of 0.46%.  This difference is significant especially in a bond fund.  This is a benefit that many advisors can bring to their clients across various investment platforms.

These just a few examples of differences in share class among the same mutual fund.  Whether you invest on your own, via a financial advisor, or within your company retirement plan; it behooves you to understand and question the various share classes available to you.  While the differences in expense ratios may seem small, the impact of a lower expense ratio can be huge in terms of the amount you accumulate over time.

Please feel free to contact me with your investment and financial planning questions.

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds and other investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

Photo credit:  Wikipedia

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Comments

  1. The basic key to investing is too keep costs low relative to returns. I’m sure you’ve seen cases where people choose to invest in higher expense ratio funds to only learn that they reduced their returns, mainly becuase of the fund expense ratio.

    • Roger Wohlner says:

      Thanks for the comment Ornella. You are totally correct. Low expenses are not everything, but they are critical. I’ve come across few if any funds with a premium price tag that end up being worth the cost. Ensuring that you are in the lowest cost share class available to you for any fund that you are either currently invested in or considering is an easy step towards reducing your investment costs.

  2. Great post! I find it interesting to read. Thanks for sharing this. :)

  3. tim says:

    Roger,
    Thanks for the post, just one thing to note. At some fund companies (continuing with your American Funds example), the C share 12b-1 gets lessened after 10 years and the C share converts to an F-1 share (at American Funds), which is the equivalent of an A-share load-waived.
    My question: what’s the difference between a C-share PIMCO Total Return (1.60% expense ratio) with a 12b-1 of 1.00% and D-share PIMCO Total Return (0.75% expense ratio) in a fee-based account at 1.00%? The C share in this case is actually cheaper for the client. Not raising an argument, I wrestle with this myself on a regular basis.
    Tim

    • Roger Wohlner says:

      Tim thanks for your comment and for visiting the site. Thanks for the clarification on the American Funds C shares, good to know. As far as your question about the PIMco Total Return C vs. D shares, after any surrender period there would be none. I am typically able to get clients into the institutional shares which are less expensive and my fees generally run less than 1%

      Interesting point about having to look at the whole picture with share classes. I serve as advisor to several local 401(k) plans. We were looking at going to a cheaper share class for one of the funds in the plan, but when we took into account the revenue sharing (that goes only to those participants investing in this fund) it was actually a better deal to stay with the retail share class.

      • tim says:

        No worries. I would agree that the C-share doesn’t make sense in a 401(k) plan at all. We specialize with individual clients, so we are really heavily evaluating the C-share vs. D-share with a fee discussion. The surrender charge is a great point. At this point, clients who are accumulating in smaller accounts, the A or C share makes sense, and larger accounts are a better fit for the institutional share class with a fee. Just to let you know where we’re at. Thanks for having this discussion!

        • Roger Wohlner says:

          Tim to clarify, the 401(k) fund was not a C share, but rather the investor share class of a no-load fund vs. the institutional share class. Most of our clients by number are individuals, revenue is about 50/50 between individuals and institutional (retirement plans, foundations, endowments) clients.

          I gather you work via a B/D and not sure how much of your business is fees vs. commissions. Smaller accounts are tough, you want to provide great service and value, but you do need to get paid. We are fee-only and moving more and more to flat, comprehensive fees and away from AUM % based fees.

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