Study Guide: Series 65

Stocks and Mutual Funds - Mutual Fund Classes, Sales Charges and Expenses


Share Classes
What's another way to classify different types of mutual funds? By looking at sales charges - specifically, whether or not there is a sales charge paid to a financial adviser as a result of the investment. If there is no such charge, the fund is known as a no-load fund.

For funds with a sales load, there are typically several classes of shares, each with a different set of sales charges and other expenses:
  • "A" shares
    • These have "front-end" loads and are sold at the public offering price (POP),which consists of the net asset value (NAV) of the fund plus the sales charge.

    • This charge is calculated by subtracting the NAV from the POP, and then dividing that number by the POP.

    • As an example, if the fund has an NAV of $20 per share and a POP of $21.50 a share, the sales charge is $1.50 divided by $21.50, which equals a 6.9% sales charge.

    • Breakpoints are discounts available to those who invest large amounts within a single mutual fund family. They apply to "A" shares only.

      • Typically, the amount of the discount increases as the amount invested increases.

      • The large amount does not have to be invested all at one time; an investor can take advantage of breakpoint discounts by signing a letter of intent stating that the investor will reach the breakpoint level within 13 months of the initial investment.

      • Another option is the right of accumulation (ROA), which allows the investor to use amounts invested in the past to calculate the breakpoint discount.

  • "B" shares
    • Are referred to as "back-end" load funds
    • In essence, the investor purchases the funds at NAV, but the financial adviser is paid a commission as if the investor paid a front-end load.
    • If the investor sells the fund within a set number of years (typically five to eight years), then a sales charge is applied.
    • This is known as a contingent-deferred sales charge.

  • "C" shares
    • Known as "level-load" funds, for which investors pay an annual asset-based fee
    • There is usually a 1% or 2% back-end load if the investor withdraws money from the fund during the first year.
    • After the first year, no additional sales charges apply.
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Sales Charges and Expenses
  • 12b-1 fees
    • The annual fee for marketing fund shares, which is permitted by the SEC but must be approved and adopted by the shareholders
    • While this amount was traditionally quite small (typically about 0.25% in "A" shares and no-load funds), mutual fund families use a larger fee (typically about 1% of the NAV) when offering "B" and "C" shares.
    • So while advisers may tout such shares as being similar to no-load funds, in fact, there is a higher cost to own the funds each year.

  • Management Expense Ratio (MER)
    • The cost of managing the mutual fund
    • Independent of the sales charge on the fund (if any), the expense ratio includes all costs to operate the fund, including:
      • investment advisery fees
      • rent and utilities
      • salaries
      • shareholder services
The expense ratio is deducted from the income of the fund and is expressed as a percentage of the NAV. The amount must be disclosed in the prospectus.

Look Out!

You can expect several questions about fund expenses, including 12b-1 fees. Remember that 12b-1 fees are not part of the expense ratio.

Exam Tips and Tricks

Here is a sample exam question about 12b-1 fees:
  1. In order for a mutual fund to utilize a 12b-1 fee, the plan must be approved by the:
    1. SEC
    2. FINRA
    3. Mutual fund family
    4. Shareholders of the fund
The correct answer is "d". The shareholders must agree to adopt the 12b-1 fee. These fees are permitted by the SEC, but not approved by them.
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