Mutual funds are a great alternative investment. Especially in volatile markets, investing in mutual funds allows you to diversify your portfolio with a selection of different asset classes, including equities, bonds and other securities and own a percentage of the total portfolio of the investment company. In addition, mutual funds achieve the highest possible capital gains by capitalizing on investment opportunities in global capital markets. In that way, you can select from a comprehensive range of investment solutions that appeal to your investment goals based on your different risk/return preferences.
When investing in mutual funds, you can select among three different share classes that indicate the type and number of fees charged for the shares in a fund. Mutual funds are authorized to charge the 12b-1 fee to cover annual marketing and distribution expenses. In addition, the 12b-1 fee is used to pay the fees of financial advisors and insurance agents and is considered an operational expense. Typically, the 12b-1 fee ranges between 0.25 and 1 percent maximum of a fund’s net assets. If it is less than 0.25, the fund is known as no load as there are no commissions charged since the shares are distributed directly by the investment company.
The three main types of mutual fund classes are A-shares, B-shares and C-shares. Each share class incurs different fees and commissions and has various benefits.
Class-A shares charge a front-end load, usually 4-5 percent of the fund’s net assets, which is withdrawn from your initial investment.
Class-A shares have lower 12b-1 fees, which allow you to hold these shares on a long-term horizon. In addition, they offer better discounts at certain breakpoints. For instance, if the first breakpoint is $20,000 and you reach it, Class-A shares allow you to invest this amount to receive a discount. You can also get a discounted front-load fee if you reach the first breakpoint with the second installment. For instance, if the first breakpoint is $20,000 and your initial investment is $12,000, by investing another $8,000 you reach the first breakpoint on the second installment. This is known as the right of accumulation. Finally, Class-A shares give you the right to receive front-end load discounts if you initially express your intent to invest an amount over a certain breakpoint by a certain point in time. This is known as letter of intent.
On the other hand, Class-A shares require a high initial investment in order to be able to reach the first breakpoint within the specified period in the letter of intent. If you fail to do so, you will be asked to pay regular front-end fees. In addition, Class-A shares are optimal for investors with a long-term horizon so that you have time to incur any fees and realize profit.
There are no up-front commissions with Class-B shares, but there are redemption fees if your shares are redeemed within 5 years. Redemption fees range between 3-5 percent, if the shares are redeemed in the first year. In addition, there are 12b-1 fees incurred, but you have the right to convert your Class-B shares to Class-A shares after year 6.
Typically, Class-B shares require long-term investment, but if you withdraw your funds before a certain period you are charged with deferred sales charge. In addition, there are no breakpoints and therefore no discount offered if you reach a certain amount. Class-B shares have also high expense ratios, which means high annual expenses expressed as a percentage of the fund’s assets.
You are not charged with up-front fees or redemption fees if you hold your Class-C shares for 1 or 2 years. This allows you to earn interest income on your initial investment. On the other hand, you may be charged with 1 percent back-end load if you withdraw your funds within the first year. In addition, Class-C shares have high expense ratios, although lower than those of Class-B shares. Finally, Class-C shares cannot be converted into Class-A shares and therefore they are optimal for short-term investment so that you can redeem them within two years and avoid high management fees. Also, Class-C shares offer no discount for reaching certain breakpoints.
Investing in mutual funds can be really profitable provided you get familiar with different share classes to minimize fees and maximize profits.