The concept of pooling capital of individual investors into a common fund is at least as old as the Dutch investment trusts of the late 18th century. The modern mutual fund harkens back to 1924 with the institution of the Massachusetts Investor’s Trust, forerunner to present-day MFS Investment Management. Today, investors have over $15 trillion invested in U.S. mutual funds, an amount nearly equal to a year’s worth of GDP.
Yet many of those investors do not realize that how they buy their funds is nearly as important as which funds to buy. Returns from a great fund can be significantly impaired by owning the wrong class of shares with high expenses and sales charges. Understanding the different share classes and choosing carefully is critical over the long haul.
Mutual fund companies utilize a variety of marketing channels to sell their products, some more costly than others. The same investment product can be packaged into various wrappers and cost structures. Mutual funds sold by brokers generally fall into one of three classes.
Class A shares are subject to an up-front sales charge or “load,” typically between 3 and 6 percent of the amount invested, to compensate the broker and the broker’s firm. In addition, class A shares carry an ongoing annual marketing expense, called a 12b-1 fee, of around 0.25 percent per year. Class A shares generally involve the lowest ongoing annual expenses over time, but are only appropriate for long-term holders given the high up-front commission.
Most funds offer volume discounts on the front loads, reducing the sales charge if the initial or subsequent investment exceeds certain thresholds called breakpoints. Loads phase out entirely for very large investments.