Class B Mutual Fund Shares: Do They Make the Grade?
Buying mutual funds through a broker or other investment professional usually means choosing among different mutual fund classes. The only differences among these classes is how much you will pay in expenses and how much your broker will be paid for selling you the fund.
We are issuing this alert because we are concerned that some investors may purchase class B mutual fund shares when it would have been more cost-effective for those investors to purchase a different class of shares. In general, be cautious when the total dollars being invested in a particular fund family's B-share—the trade plus assets already managed by that family—exceeds $100,000.
Before purchasing any mutual fund share class, determine whether that class is in your interest and not just in the interest of your broker or adviser. They may receive higher commissions from the sale of one share relative to others.
Class B shares do not impose a front-end sales charge. However, they charge higher expenses than A shares for a period of, normally, four to eight years. Class B shares also normally impose a contingent deferred sales charge (CDSC), which you pay if you sell your shares within a certain number of years, normally before the end of six years.
In addition, investors who purchase class B shares cannot take advantage of breakpoint discounts available on large purchases of class A shares.
This alert will explain the differences between mutual fund share classes. It will explain how to evaluate which class may be best for you and suggest some questions you might ask of your investment professional.
A mutual fund may offer more than one "class" of shares to investors. Each class represents the same interest in the mutual fund's portfolio, but has different fees and expenses. Your broker may also be compensated differently depending on which class you choose. When deciding which share class is best for you, carefully consider:
You can find out if a mutual fund has different classes by looking at the prospectus. The most common share classes—A, B, and C—are described below.
These shares typically charge a front-end sales charge or "load" that is deducted from your initial investment. Often class A shares offer you discounts, called breakpoints, on the front-end sales charge if you:
Typically, there are several breakpoints. As you invest more, and reach these thresholds, there is a greater reduction in the sales load. Breakpoints and the savings they provide are explained in our Investor Alert Mutual Fund Breakpoints: A Break Worth Taking.
Sample Breakpoint Schedule (Class A Shares)
Class A shares also charge management fees and 12b-1 fees. Management fees for all shares of any fund are the same (but differ across funds). However, 12b-1 fees on A shares are generally lower than the 12b-1 fees of class B and C shares. Because of lower 12b-1 fees, total operating expenses on class A shares, over time, are generally lower, too.
What Are 12b-1 Fees?
Named after the Securities and Exchange Commission (SEC) rule, these are the fees that you do not directly pay, but which are taken out of a mutual fund's assets annually to cover the costs of marketing and distributing the fund to investors. Like sales charges, 12b-1 fees can be used to compensate a broker or other investment professional.
These shares do not impose a front-end sales charge that is deducted from the initial investment. All of your dollars go to work for you, unlike A shares where the sales load is deducted before dollars are invested. B shares do impose a 12b-1 fee that may be higher than what you would incur if you purchased class A shares. Class B shares also normally impose a contingent deferred sales charge (CDSC), which you pay if you sell your shares within a certain number of years. The CDSC normally gets smaller each year and, eventually, is eliminated after several years, usually six.
Sample CDSC Schedule (Class B Shares)
Selling class B shares during the period in which the CDSC applies can significantly diminish the overall return on your investment.
Most class B shares "convert" into class A shares after a certain number years. When they convert, they begin to charge the same annual fund operating expenses as class A shares, which is lower. Some B shares convert to A shares after six years and almost all convert by the end of eight years. Each fund's pricing and conversion features are unique. All else equal, a shorter conversion period is better than a longer one.
In some cases, if you hold B shares long enough, despite higher 12b-1 fees, you may pay less overall than had you paid an up-front sales load on A shares. The only way to know is to run an analysis using readily available software, like FINRA's Fund Analyzer.
Keeping Track of B Shares
If you own class B shares, keep track of when they are scheduled to convert to class A shares particularly if your shares are held in an account that's been transferred from one brokerage firm to another. You can find out when your B shares convert by looking at the prospectus or by checking with your broker or adviser.
These shares typically do not charge a front-end sales charge. All of your dollars go to work for you right away. Class C shares generally impose a lower CDSC than class B shares (e.g., 1 percent) and for a shorter period, such as one year.
Like class B shares, C shares typically impose higher annual operating expenses than class A shares due, primarily, to higher 12b-1 fees. Unlike B shares, they typically do not convert to class A shares and, instead, continue to charge higher annual expenses (including 12b-1 fees) for as long as the shares are held.
Class C shares may be less expensive than class A or B shares if you have a shorter-term investment horizon because you will pay little or no sales charge. However, your annual expenses could be higher than class A shares, and even class B shares, if you hold your shares for a long time.
Not all mutual funds charge sales loads. Called no load funds, these funds do not charge a front-end sales charge or a deferred sales charge, such as a CDSC. NASD rules require that the 12b-1 fees not exceed 0.25 percent of the fund's average annual net assets in order to call itself a no load fund. Therefore, the annual expense of a no load fund is lower, in general, than for load funds.
No load funds can be purchased directly from a mutual fund company or brokerage firm fund supermarket, but you won't receive the assistance of a broker or investment professional. For those wanting professional advice, no load funds may be purchased from an investment adviser, but you'll typically pay an annual fee for this advice. This means you will pay a fee on top of the underlying mutual fund expenses.
Mutual Fund Classes Comparison Chart
|Class A||Class B||Class C|
|Front-End Load||Initial sales charge. Can be reduced or eliminated by breakpoint discounts||None.||Generally none.|
|Contingent Deferred Sales Charge (CDSC)||None.||Declines over several years.||A lower CDSC than class B and eliminated after one year.|
|12b-1 Fees||Typically, lower than class B and C shares.||Typically, higher than class A shares.||Typically, higher than class A shares.|
|Converts to class A Shares||N/A.||Convert to class A shares after several years, thereafter reducing expenses.||Generally no. Annual expenses remain at class C level.|
When making large purchases of class B or class C shares—normally over $50,000 or $100,000—you cannot take advantage of breakpoint discounts that may be available on class A shares.
Abuses regarding the unsuitability of large sales of class B and C shares have been investigated. See NASD Brings Enforcement Action For Class B Mutual Fund Share Sales Abuses And Issues Investor Alert on Class B Shares and NASD Charges New York Broker Todd M. Eberhard with Numerous Sales and Reporting Violations.
If you intend to invest an amount large enough to qualify for breakpoint discounts, always discuss with your broker or financial adviser whether class A shares would be most suitable for you.
If you are considering a recommendation to purchase class B or C shares, take the following steps:
Know What You're Being Asked to Sign
If your broker asks you to sign a written disclosure agreement stating that it is your choice to buy class B or C shares, make sure you read the agreement and understand it. Take it home, think it over, or discuss your options with others.
If you believe that a sale of a mutual fund share was improper, you can file a complaint online at FINRA's Investor Complaint Center.
FINRA Fund Analyzer
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