Mutual funds offer investors access to a professionally managed, diversified portfolio of securities that would be difficult for a small investor to replicate. While the concept of a mutual fund is beautiful in its simplicity, actually investing in one can be complicated.
To a great extent, mutual funds are still sold, not bought. This might seem like an insignificant twist of semantics, but it can make a huge difference in how your investments perform.
In general, mutual funds can be divided into two broad categories. “Load” funds levy a sales charge, paid for by the investor, used to compensate financial advisers for their advice in choosing the fund.
“No-load” funds, by contrast, are for the do-it-yourself investor and do not carry a sales charge. It’s like buying directly from the manufacturer, cutting out the cost of the middleman. Since there is no sales charge from which to pay the adviser, it is highly unlikely a commission-based (vs. fee-only) adviser will ever recommend a no-load fund, regardless of its merit. We are very familiar with this phenomenon.
One load fund can have a confusing alphabet soup of 12 or more different classes of shares, but the three primary classes are “A,” “B” and “C.”
Buyers of “A” shares pay a front-end load at time of purchase. Assume you write a $10,000 check for the purchase of “A” shares with a 5 percent load. $500 is deducted immediately to pay the adviser. Only the remaining $9,500 is actually used to purchase shares, which have to gain 5.26 percent just to get you back to even, a very deep hole to escape.
Buyers of “B” shares pay a deferred or back-end load when the shares are eventually sold. In the above example, the entire $10,000 is used to purchase shares. The sales load, which decreases to 0 percent over a set number of years, is deducted from the sales proceeds. However, “B” shares don’t ever actually escape paying a load, even at 0 percent. Distribution and service charges (12b-1 fees) on “B” shares tend to be higher than those for “A” shares. While the back-end load decreases over time, the accumulated 12b-1 fees can offset most or the entire decline.
“C” shares charge a “level load” that remains at a constant rate, also via an elevated 12b-1 fee. However, unlike “B” shares, “C” shares never convert to “A” shares. This means you are paying a load for as long as you own the shares, which can be a very expensive proposition.
Sales loads are a significant drain on performance, but you don’t have to pay them. Lipper and Morningstar research and rank thousands of no-load funds. Fund supermarkets such as Charles Schwab, Fidelity, TD Ameritrade and ETrade offer easy-to-use screening tools.
If you choose to use an adviser, never make an investment until you understand the charges and expenses and exactly why your adviser is recommending a particular fund and share class. Financial incentives can color the advice you receive, so check it by using the Financial Industry Regulatory Authority’s fund analyzer tool at www.finra.org.
Protect yourself. Know what you’re paying and why.
Mickey Kim is the chief operating officer and chief compliance officer of Columbus-based investment adviser Kirr Marbach & Co. He can be reached at 376-9444 or firstname.lastname@example.org.
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