Educational Programming Video
The Value Line Mutual Fund Survey
Program #8: Share Classes
Over the next couple of sessions, we'll be discussing some mutual fund basics that every fund investor should know. Today, we're going to focus on the differences between share classes.
When looking for a mutual fund, many investors are taken aback by the plethora of options available. There seems to be a fund available for every potential investment need. This is basically a good thing since more options mean you can really fine-tune your fund selections to meet your investment needs. The shear number of choices, however, can be overwhelming. But take heart, the good news is that things aren't as complicated as they look.
You see, not only can you choose funds based on their investment objectives, you can also select funds based on how you want to pay for those funds. Thus you will see XYZ Growth Fund A and XYZ Growth Fund B being offered. Both of the funds have the exact same portfolio, but different payment schedules. This is important to note, since they are, at the core, the same fund. The manager is the same, the management style is the same, the holdings are the same. The only difference is how you pay for the fund.
We mentioned in a previous session that there are over 11,000 open-ended mutual funds out there. But, because of the different share classes, that number is actually a little bit inflated. The vast majority of fund families offer more than one share class of the same fund. So, from the standpoint of an individual investor, the number of funds from which to choose is much smaller. Share classes really add a second dimension to the selection process; they give you the option to choose how you want to pay for a fund. When I say pay for the fund, I don't mean cash, check, or charge, I mean a fund's load or commission structure.
On the broadest level possible, funds either charge you a commission to buy the fund or they don't. Funds that do not charge a fee or "load" are called no-load funds. Funds that levy a fee are called load funds. We discussed the general concept of a load fund in an earlier session, but, to review bit, sales loads come in two basic forms; front end and back end. Front-end loads are paid upon purchase, and back end loads are paid upon the sale of the fund. Of course things aren't this simple in the real world. There are many other options out there, but lets look at the three basic options before getting into the others.
A no-load fund is fairly simple to understand. You don't pay a fee to buy the shares, so, when you invest $5,000 you buy $5,000 worth of the fund. And, when you go to sell the fund, there is no fee to do so. This type of fund is best suited to the investor who does all his or her own mutual fund research. Why pay someone else if you do all the work of selecting a fund. If, however, you use a financial advisor, that advisor deserves to be paid for his or her work. This is where the A- and B-share classes come into play. Basically, the load is levied to pay your financial advisor, be it a broker or financial planner, to sell the fund to you.
In most circumstances, A-shares are front-end load funds. That means that the investor pays a fee to buy the fund. For example, if you invested in a fund with a front end load (one that you pay upon purchase) of 5%, a $5,000 purchase would buy $4,750 worth of shares. And, when you go to sell the fund, you don't pay any fees. Front-end loads are usually dependent on the amount of money being invested, the more money invested, the lower the load gets. Most loads go down to 0% if you invest a significant enough sum of money.
For a fund with a back-end load, however, the reverse is true. You do not pay anything to buy the fund, but when selling you must pay a fee. Ultimately, you receive the value of your shares minus the sales load. So, if the back-end load is 5%, and you sell $7,000 worth of the fund, you would receive $6,650. Back-end loads are time dependent, getting lower the longer you own the fund. After a number of years, many of B-share funds turn into A-shares and selling the fund will result in no back-end charge. B-shares often have higher operating expenses than A-shares, so, on an ongoing basis, you pay more for the day to day running of the fund. Operating expenses will be covered in more detail later.
This should give you a good start for understanding loads. Of course things aren't always this simple, so next time I'll talk about the other share classes that are available and highlight some of the biggest differences between the different types of funds.