Chapter 2-4 Mutual Fund Fees

All mutual funds charge fees.  Since even the most miniscule percentage variations can amount to a large dollar disparity in the returns on your mutual funds, it is essential to be informed of all the fees connected with any fund you invest in.  It is also important to analyze how sales loads and breakpoint discounts, fees, and other mutual fund costs can affect your return.  Fees can be charged at particular times, based on your activity, or can even be charged on a continuous basis.  Fees are explained specifically in every fund’s prospectus, which you should make sure to read prior to investing in any fund.

One type of fee that may be charged on a continuous basis is a management fee.  These fees compensate the fund’s portfolio manager.  Another type of fee is a 12b-1 fee, which is restricted at 1 percent of your assets in the fund.  12b-1 fees compensate for the price of marketing and selling the fund, for a portion of the shareholder services, and at times as payment for employee bonuses.  Additional charges include the price of offering services to shareholders apart from the costs paid for by the 12b-1 fees or the portfolio management fees.  You may also pay execution fees for the trades that the fund executes.  However, these execution fees are not accounted for individually as the other fees are.

Some fees depend on the activity you may do.  One such fee is an account fee.  Funds may charge you a separate fee to manage your account, particularly if your investment goes down past a fixed dollar value.  Another type of fee that you may be charged is a redemption fee.  Oftentimes funds charge a redemption fee to shareholders to hinder very short-term trading.  They can be charged from a few days to more than a year.  That’s why it is essential to comprehend if your fund imposes redemption fees and how they impose them prior to purchasing, particularly if you believe that you might need to sell your shares soon after buying them.  Exchange fees are another fee that you may be charged.  Exchange fees are charged for transferring your money from one fund to a different fund provided by the same investment company.  You may also be charged purchase fees, which a fund may charge when you purchase shares of the fund, whether or not the fund assesses a front-end sales charge.

A simple technique for comparing mutual fund fees is to search for a number labeled the Total Annual Fund Operating Expenses, also referred to as the fund’s expense ratio.  The expense ratio can be found in a fund’s prospectus, in financial publications, or on the fund’s website.  It states the percentage of the fund’s complete investments that goes into compensating for its occurring fees each year.  The greater the fund’s fees, the higher its odds with regard to performing more effectively than the total market as calculated against the appropriate benchmark.

You should also be knowledgeable of transaction fees.  Transaction fees are paid to a brokerage firm to implement its buy and sell orders.  They are not part of the expense ratio, but are applied prior to the fund’s return being measured.  The more the fund buys and sells in its portfolio, which is known as its turnover rate, the higher its transaction expenses may be.

As an investor, you may have learned about Class A, Class B, Class C, or additional classes of mutual fund shares.  If you are considering selecting one of these classes, it is essential for you to understand the differences between them.  An individual mutual fund, with one portfolio and a single investment adviser, may provide more than one class of its shares to investors.  Each class represents a related concern in the mutual fund’s portfolio.  The main distinction among the classes is that the mutual fund will charge you various fees and expenses based on the class you select.

When you purchase mutual fund shares from a stockbroker or other investment professional, you might be required to pay a sales charge, known as a load.  These are measured as a percentage of the total you invest.  Like commissions on stock or bond transactions, these charges pay the broker for their time spent working with you in choosing the right investment.

The charge rate differs from company to company.  Moreover, companies may provide various classes of shares, which impose the charge at various times.  You should make sure you recognize the financial implications of selecting a particular share class prior to buying a fund.

The first class of shares is called Class A shares.  They have a front-end load, which is a commission you pay when you purchase the mutual fund shares.  The typical range is from 2 to 5 percent, however it differs.  This amount is taken away from the amount you are investing in the fund.  For instance, if you invest $10,000 in a fund with a 5% front-end load, $9,500 of your investment would purchase fund shares, and $500 would go to your broker.

Class B shares are the next class of mutual fund shares that we are going to take a look at.  Class B shares do not charge a sales charge when you buy them.  Unlike Class A purchases, all of your money is invested right away.  Class B shares have a back-end load.  With a back-end load you pay a fee when you sell your shares, generally several years after you buy the shares, however it could be more or less.  Often, the load declines, possibly by a percentage point every year, until it goes away completely.  Because of this, the annual fees that the mutual fund charges on Class B shares are more than the fees on Class A shares.  Back-end loads are also referred to as contingent deferred sales charges (CDSC).  In a period of two years after the CDSC has been removed, Class B shares often turn into lower-cost Class A shares.  When this switch occurs, the shares begin to charge the same fees as Class A shares.

If you are planning on buying a large amount of Class B shares, you may want to discuss with your financial adviser if Class A shares would be better.  The expense ratio charged on Class A shares is typically less than Class B or Class C shares.  The mutual fund may also grant breakpoint discounts when you make big purchases on the front-end sales charge for Class A shares.  You can look through the mutual fund’s prospectus to figure out if Class A shares are more beneficial.  The mutual fund’s prospectus may also specify the purchase totals that are needed for a breakpoint discount.

Another class of mutual fund shares is called Class C shares.  Class C shares may have a level load.  This load is obtained by the mutual fund for each year that you retain the fund, or may carry a back-end load or contingent deferred sales charges, very much like Class B shares.  Class C shares have a tendency to carry larger annual fees than Class A shares, generally in line with those that pertain to Class B shares.  Furthermore, Class C shares do not change to a different share class.

As with Class B shares, Class C shares do not charge a front-end sales charge on the purchase, so the entire amount that you contribute is invested.  Frequently Class C shares charge a small charge, generally 1 percent, if you sell your shares in a brief time, typically within a year.  They usually charge greater asset based sales charges than Class A shares and because they typically do not turn into Class A shares, those fees will not be lowered over time.  Oftentimes, your entire cost would be more than with Class A shares, and even Class B shares, if you retain them for an extended time.

Front-end Load

Back-end Load

Convertible

Breakpoints

Annual Fees

Class A Shares

X

X

Lowest

Class B Shares

X

X

Class C Shares

X

Highest

 

The fourth class of mutual fund shares is known as no-load funds.  No-load funds do not assess sales charges and you generally purchase shares right from the investment company that provides these funds.  The same funds may be purchasable, with a load, from investment professionals.  While no-load funds do not have any sales charges, they may nonetheless charge 12b-1 fees, purchase fees, redemption fees, exchange fees, and account fees as well as the managing fees that every fund charges.

At times load funds give volume reductions for larger investment totals.  For example, your Class A shares sales charges may be lowered if you invest a particular amount.  When the dollar total of your mutual fund purchases gets to a predetermined level, referred to as a breakpoint, you are qualified to pay a lower sales load.  The totals at which your sales charges go down are referred to as breakpoints.  Generally, there are various breakpoints, as you invest more and surpass these levels, the greater the decrease in the sales load.  The breakpoints vary for every fund; your broker must advise you on what they are and is responsible for implementing the breakpoints if your investment meets the requirements.

Mutual funds are not obligated by law to provide breakpoint discounts on front-end load funds, and even though many do, some do not.  No-load mutual funds and the majority of mutual fund share classes besides Class A shares do not provide breakpoints to investors because these funds do not charge front-end sales loads.

You may also qualify for a lower front-end sales load on the basis of an individual mutual fund execution if the dollar amount of that execution surpasses one or more breakpoints.  Since every fund’s breakpoint agenda and procedures differ, you should learn how breakpoints function at funds where you and your family have considerable investments.  The majority of funds let you meet the requirements for a breakpoint discount based on the total you invest at an individual mutual fund.  However, there are additional methods of receiving a breakpoint discount.  For instance, you may be capable of meeting a breakpoint discount based on joining your existing purchase with purchases you’ve executed at various times, purchases you plan on making in the future, purchases of additional funds within the same fund of funds, purchases you’ve executed in different accounts (even accounts at different firms), or purchases by your immediate family members such as your spouse or child.    A mutual fund’s procedures on rights of accumulation and letters of intent typically clear up how you can join these different mutual fund purchases to meet the requirements for a breakpoint discount.

Breakpoint regulations vary, however a number of funds allow you to meet the requirements for breakpoints if your total investment is in the same fund family, meaning funds provided by the same fund company, amount to the breakpoint level.  A number of funds also permit all of the investments made by every member of your household to figure into the breakpoint.  Moreover, some funds allow you to meet the requirements for a breakpoint as time goes by, rather than with an individual investment, by totaling up your previous investments to your current ones.  A right of accumulation (ROA) generally grants you a discount on your existing mutual fund purchases by joining both your existing and past fund transactions to get to a breakpoint.  A fund’s procedures concerning right of accumulation describes how an investor can mix accounts and which kinds of accounts are qualified for breakpoints.

Mutual funds use various techniques to price your pre-existing holdings to figure out if you meet the requirements for a breakpoint.  The majority of mutual funds use the current net asset value (NAV) of your holdings, which is the dollar total for which you could sell your holdings.  However, a number of mutual funds utilize the current Public Offering Price (POP), which is the NAV plus the highest sales load that you would have received for the shares.  A number of mutual funds also let you to utilize the higher of the market value (NAV or POP) or the past investment expense, which is the price that you actually paid for the shares.  When the stock market is down, past expenses may surpass the market value.

You may even meet the breakpoint if you write a letter of intent (LOI), telling the fund that you are intending to invest the adequate amount to qualify for the breakpoint in the future.  If you can’t invest the minimum total needed to generate a breakpoint discount but you are expecting to make further investments over the approaching months, you still may be able to get a lowered sales charge through a letter of intent (LOI).  A lot of fund companies allow you to add purchases done within 90 days prior to the LOI being signed and within 13 months following the LOI being signed in getting to the dollar total of the breakpoint level.  If you anticipate on investing routinely in a fund that has a front-end sales load, it is beneficial to learn if a LOI can assist you in meeting the requirements for a lower charge.  However, if you fall short of investing the total stipulated in your LOI, the fund can collect the higher fees on past occurrences.

Funds can grant breakpoints by more than one method, or they may not provide them entirely.  If you are eligible for breakpoints, the fund is obligated to implement them to your investment.  In the case of either rights of accumulation or letters of intent, you typically may use mutual fund executions in additional affiliated accounts, in various mutual fund classes, or in various mutual funds that are from of the same fund family, for your discounts.  For instance, a fund may let you to reach a breakpoint discount by joining your fund purchases with the ones of your spouse or children.  You also may be allowed to use mutual fund executions in retirement accounts, educational savings accounts, or in accounts at different brokerage firms.  Every mutual fund and family of funds establishes their own breakpoints and the circumstances through which discounts are accessible.  These terms and conditions vary from one fund to another, and they also can alter.  You can view data on breakpoints in the mutual fund prospectuses or Statements of Additional Information and on numerous mutual fund company websites.

If you have previously made a mutual fund purchase through your broker, you may want to look over your account statements and confirmations to check if you have received the correct breakpoint discount.  If you have any reason to believe that you did not get the appropriate discount, call your broker and ask that the discount be exercised.  In the majority of cases, your account will be immediately fixed.  If your broker does not fix your account or give you a reason that you comprehend, proceed by writing to the firm’s compliance department.  If you are not happy with the firm’s answer, you can file a complaint online at the FINRA Investor Complaint Center.

There are numerous actions you can go through to ensure that you are paying the minimum price for a fund that charges a front-end sales load.  The first action that you can take is to be aware of how breakpoints operate.  Review the mutual fund prospectus or Statement of Additional Information, go to the mutual fund company’s website, or question a financial professional for information on the terms and conditions of any accessible breakpoints.  Another action that you can take is to check your mutual fund holdings thoroughly.  Prior to buying a mutual fund, look over your account statements and those of your family to find the totals of investments in a specific mutual fund or family of funds to see if these executions can be joined to receive a breakpoint discount.  Do not restrict your analysis to accounts at an individual brokerage firm.  You may have associated mutual fund holdings in accounts at additional brokerage firms or within the mutual fund company itself that can assist you achieving a breakpoint discount.  A third action that you can take to ensure that you are paying the minimum price for a fund is to keep your broker notified.  Make sure that you inform your broker about your mutual fund holdings and of those of your family, including holdings at additional brokerages or with the mutual fund itself.  Also tell your broker about any intentions you may have for making any further purchases.  Your broker can ensure that you get all possible breakpoint discounts with this information.   Following your front-end sales load mutual fund purchase, follow up to check that any appropriate breakpoint discounts are exercised accurately.  You can accomplish this by analyzing the purchase agreement or the first account statement you get following the purchase.

Breakpoint discounts raise the possible earning power of your investments by letting you invest more of your money in the fund rather than using it to offset sales charges.  That’s why it is worthwhile to understand how your fund’s breakpoint discount plan is set up so that if you meet the requirements you can make sure you get the maximum discount.  Breakpoints can provide notable savings on front-end sales charges.  The financial services industry, along with securities regulators, are actively working to guarantee that brokers and investors completely understand how breakpoints function to ensure that everyone that is eligible gets the right breakpoint discount.

Questions