Ask a planner: Watch for hidden costs on funds
Q. I just retired with $397,000 in my 401(k). My broker recommends rolling it to an IRA and buying mutual funds. He likes C shares because there’s no commission. What do you think?
A. As a fund investor, you should understand the costs you might encounter. First, all funds charge “asset-based” fees for ongoing investment and administrative costs. They’re easy to overlook because they’re not deducted directly from your account. But they can bite into your return. Second, some funds have loads (commissions, sales charges) and offer multiple share classes. Here’s a quick review of the A, B and C shares.
Class A: You pay a load when you buy Class A shares, most of which is paid to your broker. The amount depends on how much you’re investing. For example, you might pay 5 percent if you invest $10,000, 3.5 percent if you invest $100,000, or nothing if you invest $1 million.
A breakpoint is where the load drops. Class A shares have the lowest asset-based fees. Your broker may receive a small part of it (usually 0.25 percent) for servicing your account.
Class A shares are a good choice for most long-term investors, especially those with larger amounts to invest.
Class B: Although you don’t pay a commission when you buy Class B shares, your broker receives one, comparable to the maximum Class A load. Here’s how this works: The fund increases its asset-based fees so it can recover the commission over six or seven years. If you sell during this time, you pay a contingent deferred sales charge, allowing the fund to recover the rest. For example, the charge might be 5 percent if you sell within two years. Then it might drop by 1 percentage point annually until it reaches zero. At this time, some funds convert B shares to A shares.
Since there are no breakpoints, most funds won’t accept investments of $100,000 to $250,000 or more in Class B shares. Again, your broker may receive a small part of the asset-based fee.
Class B shares may be an acceptable option for long-term investors with small amounts to invest.
Class C: Like Class B shares, you don’t pay a commission when you buy Class C shares, and your broker may or may not receive a nominal commission. But you will pay a small contingent deferred sales charge (usually 1 percent) if you sell within one year. How does your broker get paid? Again, the fund increases its asset-based fee. But this time it pays the broker a larger portion (usually 1 percent) to service your account.
Unlike Class B shares, C shares are never converted to A shares, so this increased cost is forever. Class C shares are best suited to investors with a short to intermediate time frame.
A reputable broker will never represent A, B or C shares as being commission-free. Instead, he or she will explain their differences and recommend the option suitable for you.
You can research the fees and expenses for more than 18,000 funds using the Fund Analyzer at www.finra.org.
Greer Gibson Bacon is a certified financial planner and member of the local Financial Planning Association chapter. Readers are invited to submit questions on financial planning to be answered in this space each Tuesday. Send questions to firstname.lastname@example.org.