Mutual Fund Buying Made Easier

By Bob Moeller
WEAC Member Benefits

April 2002

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Last month’s article dealt with problems you might have with brokers who charge too much in service fees. Now, we look at mutual funds. Some funds charge higher fees for investing your money for you and, in most cases, these higher fees don’t buy you one bit of increased return. If the stock market is going to go up 10% a year on average, and you pay fees of 2% to invest in it, your return over time is a lot less than if you pay 1% to invest in it.

A simple example: $10,000 invested for 20 years, earning 10% gross a year returns $56,044 if you pay just 1% in fees; and only $46,609 if you pay 2% in fees each year. And, this doesn’t even cover sales charges! Let’s review.

Funds can pick some or all of the following charges to manage your money. Make sure you know exactly what total fees are before investing.

• A sales charge, typically in the area of 4½% to 5½% of what you invest. Most of it goes to the investment house you are dealing with and then part to your adviser. Funds you buy with this fee are frequently referred to as “A” or Class A shares on your statement.
  
  
• A termination or withdrawal fee, typically 5% of whatever you withdraw. In many funds, this charge reduces after a number of years. Funds with this charge usually also have higher annual fees and are referred to as “B” shares.
  
  Frequently, Class B shares revert to Class A shares after a number of years, at which time you begin saving on the management fees each year.
  
  
• Annual fees. In theory these are the costs you pay to manage the fund, but they may also include “12-b-1” fees which are essentially promotion fees. Relatively new are Class C shares, which have no sales charge and no or minimal withdrawal charge, but permanently higher annual management fees that do not reduce after a few years. Popular with brokers, these have been questioned even by some brokerage houses as being too costly to customers.
  

Let’s look at some examples. I meet with many members who have been sold AIM mutual funds. Here is the breakout for the AIM Constellation Fund, which is AIM’S largest fund at about $10 billion. It is considered a multi-cap growth fund (includes small, medium, large companies).

If you buy the Class A shares, you pay an up-front sales charge of 5½%. You would have no withdrawal charges. You would pay an annual total fee of 1.08%.

Class B shares have no sales charge, but a withdrawal fee on each purchase you make (called rolling) of 5% the 1st year, with an eight-year schedule of 5%, 4%, 3%, 3%, 2%, 1%, 0%, 0%. You would pay an annual fee for the eight years of 1.85% instead of 1.08%. After eight years, the Class B shares convert to Class A shares, which reduces the annual fee.

Class C shares do not have an up-front sales charge. They have a 1% withdrawal charge that lasts only one year after you made the purchase. However, you pay a 1.85% annual fee that does not reduce or change to Class A shares after eight years. Your only alternative to save the very high annual fees is to sell the Class C shares and buy Class A shares, paying a 5½% sales charge.

Which is best? Depends on how long you might intend to remain in the fund. If you must invest in a load fund, and you intend to remain in it for several years, the Class A shares are probably better. I view the Class B shares as essentially a gimmick so the broker can tell you there is no front-end load. For long-term investing, Class C shares are not advised.

So there is about $10 billion invested in this fund. That’s a lot of money. Does the long-term performance justify this kind of loyalty? As of December 31, 2001, the five-year record was 5.8%, the 10-year was 11.07%. The 10-year record is lower than most of the largest funds reported by the Wall Street Journal (January 7, 2002), and the five-year record is quite a bit lower.

Would I buy it? I try to have simple investing rules. If a fund over a long term, 10-year period did not beat the S&P 500 Index – which I can buy with no sales charges, no withdrawal fees, no 12-b-1 fees, and ultra-low management fees (less than ¼% a year) – why should I buy the fund?

In conclusion, unless you do your homework, you may pay fees and commissions that will reduce your profits. The information is readily available, and you shouldn’t hesitate to ask your adviser or broker exactly what the charges are and will be in the future when you invest. The average long-term stock returns you might get are in the area of 10%, and giving up 2% to 3% of it is something you can avoid.

Posted April 11, 2002