What Is a Sales Charge?
A sales charge is a commission paid by an investor on his or her investment in a mutual fund. A financial intermediary, such as a broker, financial planner, or investment advisor, receives the money from a sales charge. Sales charges are expressed as a percentage of the investment value.
Sales charges can be avoided by investing in no-load mutual funds or exchange-traded funds (ETFs).
Understanding Sales Charges
Many mutual funds have sales charges. Sales charges are quoted in percentages and equate to a portion of the investment. Therefore, for an investor, their actual investment in the fund is equal to the difference between the investment value per share and the total sales charge. By regulation, the maximum permitted sales charge is 8.5%, but most loads fall within a 3% to 6% range.
Investors can incur various types of sales charges, which are often associated with specific share classes of a fund. Sales charges are commission charges paid to financial intermediaries for their partnership in selling the fund. Sales charges are not paid to the fund itself, so they do not factor into the gross and net expense ratio of a fund.
Sales charges can vary across different types of funds and share classes. Many funds may not require sales charges due to distributor relationships. Investors should be sure that they clearly understand the sales charges and other fees associated with a fund. Fund companies typically provide comprehensive disclosure of their sales charges. Sales charges are also usually discussed in a fund’s prospectus.
Types of Sales Charges
Some common types of sales charges include the following:
- Front-end sales charges are paid as a percentage of the purchase price at the time of the investment. Class A shares often have front-end sales charges.
- Back-end sales charges are paid as a percentage of the selling price at the time of sale. Back-end sales charges are often associated with B-shares of a fund.
- Deferred sales charges are back-end sales charges that decline over time, often eventually reaching zero. They are also called contingent deferred sales charges because the fee is contingent on the holding period.
Criticism of Sales Charges
Investor advocates and educators frequently criticize sales charges. The most persuasive argument against sales charges is that they are entirely unnecessary for most investments today. Sales charges can be avoided by investing in no-load mutual funds or exchange-traded funds (ETFs). However, investors should be aware of the bid-ask spread on ETFs. A high bid-ask spread can be just as bad as a sales charge.
Sales charges take a bite out of investor returns, and they can be hard to spot. Some of the sales charges associated with B-shares are frequently condemned. For example, suppose that an investor intends to hold a mutual fund for many years and buys B-shares with deferred sales charges. The investor might ignore the sales charges because the desired holding period is long enough for them to go to zero. If an emergency arises and the investor needs the funds early, a sales charge of 5% or more can be a nasty surprise.
- A sales charge is a commission paid by an investor on his or her investment in a mutual fund.
- Sales charges are quoted in percentages and equate to a portion of the investment.
- The most common types of sales charges include front-end sales charges, back-end sales charges, and deferred sales charges,
- Sales charges can be avoided by investing in no-load mutual funds or exchange-traded funds (ETFs).
Examples of Sales Charges
Suppose that an investor puts $10,000 in the XYZ mutual fund with a front-end load of 5.75% for small investors. The investor’s actual investment in the fund after the sales charge would be $9,425. However, sales charges are only one of several types of fund fees that investors can reduce or eliminate.
In another case, an investor put $100,000 into the XYZ mutual fund. XYZ still has a front-end load of 5.75%, but they cut it to 4% for investments of $25,000 or more. They also reduce it to 2% for $100,000 or more, and to 1% for over $1,000,000. In this case, the investor's actual investment after the sales charge is $98,000. Notice that although the percentage has fallen, the total amount charged has increased.