Mutual Fund Class: The Pros and Cons

Intro

When it comes to investing in a mutual fund, the adage that high prices indicate superior quality could not be further from the truth. There is no evidence to suggest that paying a greater fee results in improved returns. On the contrary, a high-cost fund’s manager may take more risks to achieve a greater return, which can do the opposite. If the manager’s risky trades don’t pay off, you are the one who is losing money.

It’s crucial to consider which mutual fund class is ideal for you to avoid paying high costs only to lose money. The type of shares you select can significantly impact how much you pay in fees. In general, there are three classes of mutual funds, A, B, and C. These dictate the type of shares in a fund and the transaction fees.

Class A Mutual Funds

Class A shares are typically associated with “Load Funds.” These funds charge a fee when you buy or sell the fund. This is known as an entry load, which sets investors to purchase Class A shares. However, these fees can be waived if you meet specific requirements, such as holding your mutual fund for at least one year and investing more than $25,000 into that specific share class within five years of buying it.

Pros of investing in Class A mutual funds:

– Investing in a mutual fund with Class A shares allows you to make smaller investments.

– A front-end load is applied to Class A shares, which tend to have lower 12b-1 fees. If you expect to keep these shares for an extended period, you might profit in the long run by paying a front-end load.

Cons of investing in Class A Mutual Funds:

– You will pay higher fees, which can affect your investment returns if the market is doing well. This makes it harder for investors to get back on track after experiencing losses.

– When you sell all or some of your holdings, there may be an exit load charged by the mutual funds’ manager. An exit fee, also known as deferred sales charge (DSC), typically declines over time until the entire position is sold. This means that even though you might receive more than what you originally invested after paying off this fee, it could take you much longer to break even.

– The DSC can be as high as eight percent when initially purchasing Class A shares, which will decrease over time if your investment is held for multiple years. For example, the fee could decline by two percent every year until it becomes zero in seven years.

Class B Mutual Funds

When investors purchase mutual funds with Class B shares, they are charged a fee at the time of purchase and an additional charge upon selling their holdings. Similar to Class A stocks, this transaction fee may be waived depending on how long you’ve owned them and the amount you invested into that specific share class within five years of buying it. However, unlike other classes, where deferred load fees are eliminated, Class B shares keep charging a deferred sales charge even when you’ve sold all or some of your holdings.

Pros of investing in Class B Mutual Funds:

– Because the fee is lower than it would be for class A mutual funds, investors can save money on their initial investment amount. This makes it easier to make smaller investments with less risk.

Cons of Investing in Class B Mutual Funds:

– The transaction fee will eat into any profits from buying and selling these securities within five years after initially purchasing them. This could result in considerable losses if one experiences enough losses during that period. If an investor does not sell their entire position before the end of year five, they will pay a deferred sales charge upon selling their shares, which could be as high as eight percent.

Class C Mutual Funds

Investors purchasing mutual funds with Class C shares are not charged an entry fee but must hold onto them for at least five years before the exit load is eliminated and withdrawn from their account. This means that even though you might receive more than what you initially invested after paying off this fee, it could take longer to break even if your investment loses money during those first five years. You can invest in these types of securities by taking advantage of exit fees when buying and entering into reinvestment plans.

Pros of Investing in Class C Mutual Funds:

– Like investing in class B shares, you will save money on your initial investment amount. This makes it easier to make smaller investments with less risk. Suppose an investor does not sell their entire position before year five has ended. In that case, they may even end up saving more than what they initially put into that specific share class because there is no deferred sales charge upon exiting their holdings.

Cons of Investing in Class C Mutual Funds:

Similar to purchasing mutual funds with a front-load (Class A), if an investor experiences enough losses within their first five years of owning these securities, they may pay deferred sales charges upon exiting their holdings.

The best way to avoid paying fees is to put enough money towards your investment purchase. This way, it does not matter what class of mutual funds you buy. However, this strategy only works for bulk purchases. This is why, investors should always be aware of the pros and cons involved with each type of share class. It will help them make a well-informed decision about their investments.