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Thanks to increased scrutiny by
federal and state regulators, the mutual fund industry is
closely reevaluating its practices and policies. One of the
most popular fund share choices of the past several years
has come under question. In fact, the nation’s fourth
largest provider of mutual funds recently announced they
will no longer offer this option. Read on to learn how all
this may affect you.
To understand the current situation, you first need to
understand how load mutual fund shares are purchased. The
first option is called A-shares. I call it the ‘up-front’
option. Most load funds charge a 5 ¾% commission ‘up front’
to get in. This amount is smaller if you or close family
members already own shares in the fund family, or if you’re
making a large purchase. These reduced commissions are
called breakpoints. There are no fees or penalties when you
sell A-shares. Buying A-shares is too expensive.
The second option, and the most popular, is called B-shares.
I call it the ‘pay-when-you-sell’ option, because you don’t
pay a commission when you buy in, but you pay one to get
out. This ‘back-end’ load decreases over a full 7-year
period to zero. So the longer you own your shares, the less
penalty you’ll pay – sort of. B-shares have no breakpoints
for reduced commissions. Annual fees are much higher with
B-shares, and with the average mutual fund owner holding
their shares for only two years, B-shares aren’t a good deal
either.
The third and least known option is called C-shares. This
‘pay-as-you-go’ option charges a 1% commission annually for
as long as you own the fund. There are no breakpoints or
back-end loads. Annual fees are less than B-shares, and
slightly more than A-shares.
Federal and state regulators have become upset about the
brokerage industry’s abuse of B-shares, the
‘pay-when-you-sell’ option. These shares became extremely
popular in the 1990s. In fact, they once made up more than
90% of fund purchases. Commission-based brokers were trying
to compete with the popularity of no-load funds. Turns out
investors don’t like paying high commissions (what a
surprise!) and brokers discovered that selling ‘hidden
commission’ funds was much easier.
What investors didn’t realize is that even though they
weren’t paying an up-front commission with B-shares, the
broker certainly was earning one, usually to the tune of 4%.
In order to cover those commissions, funds charged higher
annual fees and surrender penalties that ‘locked-in’ a
client’s money for the longer term. Once again, the investor
got the short end of the stick while the broker took home
the bacon!
There has been wide-spread abuse of B-shares, with brokers
cheating investors out of lower commissions to which they
were entitled. Figuring out which class of shares is best
for the client involves work and some brokers probably made
mistakes out of ignorance. Others knew good and well what
they were doing and used the system to their own benefit.
Bottom line - B-shares were great for the mutual fund
companies, but not so great for investors. Many would have
paid less commission with A-shares and were blindly being
cheated out of thousands of dollars. (If you own both A and
B shares in the same fund family, there’s a good chance this
happened to you!) Others felt trapped in poorly-performing
funds, hesitant to move to funds with better returns because
of surrender penalties.
The questionable practices concerning B-shares have come to
light, causing sales to drop dramatically and firms paying
millions in fines. Because of their declining popularity,
Franklin Investment’s Templeton Funds will no longer offer
B-shares to their investors. Other smaller firms are doing
likewise and the pressure for change will be intensified
industry-wide.
My suggestion? Get rid of not only B-shares, but A-shares
too! Why pay 5 ¾% to get into a decent fund? It’s
unnecessary and creates potential for conflict. There are
many no-load funds that rival (or beat) top-ranked
load-funds’ performance, without all the commissions and
surrender penalties.
If you have to buy a load fund, at least take the C-share
option, unless you qualify for big breakpoints. That way
your broker will be motivated to keep you happy and you
retain the freedom to make changes.
For free, clear, unbiased advice submit your question at
www.guardingyourwealth.com/askjeff.htm.
Mr. Voudrie is a Certified Financial Planner, nationally
syndicated newspaper columnist and President of Legacy
Planning Group, Inc., a Private Wealth Management Firm in
Johnson City, TN. He can be reached toll-free at
1-877-827-1463 or at
jeff@guardingyourwealth.com. |
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