It is easy to understand how mutual fund investors can be confused by the myriad of choices when it comes to mutual fund “share classes.” For many mutual funds, there are more than three share classes for each fund within a mutual fund family. In every case, a different share class represents a different method of calculating the fees in which mutual funds levy on investors. The following are the most common share classes:
- Class A share mutual funds generally assess an upfront (one-time) commission that is paid to the broker (4.75% to 5.75% is the range). In addition, there is a lower ongoing annual fee (12b-1 fees) that is paid to the broker to service the investment.
- Class B share mutual funds do not charge an upfront load (commission), but rather have higher annual expenses and charge a contingent deferred sales charge (CDSC) if shares are sold within a certain period of time (usually 3 to 7 years). When the CDSC period expires, Class B shares “convert” to lower cost Class A shares. At the point when Class B shares convert to Class A shares, deferred charges are not assessed when the fund is sold.
- Class C shares generally do not assess an upfront load, but will assess a 1% load if you sell the fund within one year. After holding the fund for one year, there is no fee to exit the fund. However, the ongoing internal cost of class C share mutual funds are generally higher than other share classes of mutual funds.
- Class D and Class F share mutual funds are usually no-load mutual funds. While no-load mutual funds do not charge “commissions” upon their purchase, there are ongoing expenses that are assessed to investors. These ongoing expenses vary for each fund. Class D and Class F share funds can be purchased at most discount brokerage firms through their “mutual fund supermarket” platforms. Many D and F share class funds pay an annual 12b-1 fee to the brokerage firm (not the advisor that may recommend the fund). Investors considering D and F share class funds should pay close attention to the operating expense ratios (OER) as they can vary greatly.
No-Load Mutual Funds and Exchange Traded Funds
No-Load Mutual Funds
No load mutual funds generally do not assess commission fees on an initial purchase. However, like all mutual funds, there are ongoing expenses that are levied to investors. These expenses can be measured by the mutual fund’s operating expense ratios (OER). Other considerations when investing in no-load mutual funds include the following:
- No-load mutual funds purchased directly from the fund company (i.e. Vanguard funds purchased through Vanguard) generally are not assessed transaction fees.
- No-load mutual fund purchased through brokerage firms (Charles Schwab, TD Ameritrade, etc.), can be assessed transaction fees. For example, Vanguard funds purchased through Charles Schwab are assessed a transaction fee, which vary based on the size of the transaction (with minimums and maximum charges). At Schwab, the maximum transaction fee is $49.95.
- There are also institutional share classes of no-load mutual funds, which are available to institutional advisors. Institutional share classes of funds generally have the lowest operating expense ratios, due to higher minimum balance requirements.
As a note, because a mutual fund is considered a no-load fund does not necessarily make it a low-cost fund. There are many no-load mutual funds that have higher expense ratios than Class A share mutual funds (that assess an upfront commission) – especially assuming an extended holding period.
Exchange Traded Funds (ETFs)
Exchange Traded Funds (ETFs) are mutual funds (usually tracking some index). ETFs have internal fees (operating expense ratios), which are generally very low. ETFs trade intraday on the stock exchange just like stocks. In addition to internal fees, the brokerage firm “housing” the ETF charges a commission when buying or selling shares.
For discount brokerage firms like (Charles Schwab, Vanguard, TD Ameritrade, etc.) trade commissions are generally less than $15 up to 1,000 shares. Other considerations when utilizing exchange traded funds include average volume levels, the bid/ask spread, fund structure and when the fund is “reconstituted.”
Exchange traded funds represent the most rapidly growing segment of the mutual fund industry. ETFs are available in many different formats including those that invest in currencies, commodities, specific sectors, specific countries. There are even ETFs that are leveraged (and even inverse leveraged) 2x and 3x the daily performance of various indexes. The SEC has recently approved the first “actively managed” exchange traded fund – so expect many more ETF alternatives in the future.
Mutual Fund Expense Ratio Averages
Operating expense ratios (OER) should be a primary consideration when investing in mutual funds. Expense ratios vary based on a number of factors including the size of the fund (generally funds with higher asset levels have lower expense ratios) and the asset class in which the fund invests. The following is a list of the average expense ratios for mutual funds in various investment categories (according to Morningstar):
|Short Term Bond||1.00%|
|Intermediate Term Bond||1.05%|
|Intermediate Term Govt. Bond||1.03%|
|Inflation Protected Bond||1.01%|
|High Yield Bond||1.22%|
|Intermediate Term National Muni Bond||0.95%|
|Large Capitalization Stock||1.34%|
|Small Capitalization Stock||1.49%|
|Large Capitalization Foreign Stock||1.62%|
|Emerging Markets Stock||1.86%|