Mutual fund B shares: The alphabet trap
When you buy a mutual fund from an adviser, you typically have a choice of three or more classes of shares.
A shares charge an upfront commission of up to 8.5% of the amount you invest.
B shares have no upfront commission, but annual fees will be higher, and you'll be subject to a redemption charge if you sell your shares before six or eight years. Most B shares now convert to A shares after six to 10 years, so you get lower annual fees.
C shares have no upfront sales charge and no redemption charge, but they have higher annual fees than A shares. B and C are best for people with modest amounts to invest and who don't want to pay an upfront sales charge. But for those with a lot of money to invest, A shares often are best.
Most A shares offer reduced sales charges for large purchases at various breakpoints. An investor who buys $2,000 worth of Prudential Equity Income A, for example, pays a 5% sales charge. One who buys $150,000 worth pays 3.25%. For $1 million or more, there is no commission.
B and C shares don't reduce commissions on large orders. The broker gets a flat commission - typically 4% - for all orders. The client doesn't notice because the commission is paid from the fund's annual fees.
B and C shares are costly over time. A $150,000 investment in Prudential Equity Income A eight years ago would be worth $530,250 now, after subtracting the sales charge, Lipper Analytical Services says. The same amount in B shares would have grown to $515,085 - $15,165 less.
Fund companies are supposed to discourage large sales of B shares. But brokers may try to go around the rules. "We had one case where a broker tried to write a $350,000 ticket for B shares," says Clark Hooper, head of the National Association of Securities Dealers Office of Disclosure and Investor Protection. "The fund's maximum was $200,000, so they kicked it back. The broker then split the order in two," she says.
"I've seen clients come in with $700,000 portfolios, all in B shares," says Scott Leonard, a former broker, now a fee-only financial planner in Santa Monica, Calif.
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