Series 65

By Investopedia AAA

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.

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.

Introduction

You May Also Like

Related Articles
  1. Stock Analysis

    Merck Up on OncoEthix Acquisition Deal, ...

  2. Stock Analysis

    ALLETE Buys NRG Energy's Storm Lake ...

  3. Stock Analysis

    Starwood Expands in Colombia with Four ...

  4. Stock Analysis

    U.S. Bancorp to Pay $6M to Settle Trustee ...

  5. Stock Analysis

    Wells Fargo Brokerage Units Fined by ...

Trading Center