What is a Contingent Deferred Sales Charge (CDSC)
A contingent deferred sales charge (CDSC) is a fee, sales charge or load, which mutual fund investors pay when selling Class-B fund shares within a specified number of years from the original purchase date. This fee is also known as a "back-end load" or "sales charge." For mutual funds with share classes that determine when investors pay the fund's load or sales charge, Class-B shares carry a contingent deferred sales charge during a five- to 10-year holding period calculated from the time of the initial investment. The financial industry usually expresses a CDSC as a percentage of the dollar amount invested into a mutual fund. Sometimes, the finance industry may refer to a CDSC as an exit fee or a redemption charge.
- Class-A shares typically have a front-end load, but no CDSC.
- Class-B shares often have no front-end sales charge but have the potential for a sales charge upon the sale of shares.
- Class-C shares may have a lower front-end or back-end load but carry a higher overall expense ratio.
- Many consider the CDSC to be a payment for the broker's expertise in choosing a mutual fund that fits an investor's goals.
How to Avoid Contingent Deferred Sales Charges
Generally, an investment will reduce contingent deferred sales charges for each year the investor holds the security. If the investor holds the investment long enough, i.e., for the duration of the surrender period, many fund companies waive the back-end fee.
If a mutual fund investor were to buy and hold Class-B fund shares until the end of the specified hold period, they could avoid paying this type of fund's sales charge, thereby enhancing their investment return. Unfortunately, fund research indicates that mutual fund investors are holding their funds, on average, for less than five years, which often triggers the application of a back-end sales charge in a Class-B share fund investment.
CDSC Fee Structures in Different Share Classes
Class-A shares typically have a front-end load, but no CDSC. Class-B shares often have no front-end sales charge but have the potential for a sales charge upon the sale of shares. Class-C shares may have a lower front-end or back-end load but carry a higher overall expense ratio.
An investment broker may reduce sales charges if the investor makes a more substantial initial investment. The investment amount and anticipated holding period should be primary factors for the investor in determining the appropriate share class to buy. In each case, the fund's load is a way for a financial advisor to receive a sales commission on the transaction.
Effects and Purposes of Contingent Deferred Sales Charges
CDSCs tend to discourage investors from actively trading mutual fund shares, which would require mutual funds to keep significant levels of liquid cash on hand. Many consider the CDSC to be a payment for the broker's expertise in choosing a mutual fund that fits an investor's goals. On prospectuses, mutual funds must disclose CDSC and other fees, so that investors may evaluate all costs associated with an investment along with other investor-specific factors such as risk tolerance and time horizon.
Real World Example
The American Funds Growth Fund of American Class B (AGRBX) is an example of a fund with a contingent deferred sales charge. It has no front-end sales charge, but the investment assesses the CDSC on certain redemptions made within the first six years that an investor owns the shares. The CDSC starts at 5% in the first year and gradually declines to 0% by the seventh year.