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When buying shares of common stock, Class A typically (but not always) signals a superior status, often having to do with voting rights. Of course, it’s natural to think of an “A” in terms of the best grade, but buyers of mutual funds should beware. The Class A fund is not always your best bet.
There are several mutual fund share classes, but the three most common are A, B and C. Each grade comes with its own set of regulations that cover the timing and the amount of sales commission you’ll pay.
What’s right for you? That depends on many factors, including your investment time frame, your level of commitment to a particular fund and the amount you have to invest. If you’re investing for retirement, the main thing you’ll need to consider is how long you have until retirement, and whether it makes sense to pay a sales commission now or later.
Here’s a quick synopsis of the different types of funds, but for all the details be sure to carefully read the prospectus of the fund you’re considering buying.
Class A: Sales commissions are front-end loaded, meaning they come off your initial investment. The good part about this is that you pay upfront. But this also means that you need to be committed to holding the shares for some period of time to recoup these costs.
Class B: You pay no fee up front but your sales charges are deferred and the expense ratio tends to be larger than with Class A. While this enables you to get into an investment with a smaller upfront cost, it generally means that you’ll benefit most by holding for the long term, since the longer you hold the fund, the lower your relative cost will be.
Class C: These funds charge no front-load commissions and a relatively small back-end load, so they are easier to get in and out of and can be a good option if you are not committed to holding your investment for the long haul.
Conversions and Breakpoints
This is where it gets a little more complicated:
- Class A funds usually come with “breakpoints,” which essentially reduce the sales fee as your holdings increase. If you’re a high-roller investing upwards of $1 million in a fund, the fee you pay could start to approach zero, and you may even be entitled to a refund for earlier fees paid.
- Class B funds don’t come with breakpoints, but they will typically convert to Class A over a period of time.
- Class C funds don’t convert, which means that you won’t have the option of shifting to a lower fee schedule over time, although you still benefit from the lack of front-end fees.
Confused? That’s because you’re not going to find definitive answers in the letter grade. So do your research. Investors often overlook what they’re paying in fees, and they can add up. It could even make the difference between surpassing your investment goals or falling short. Still, the best way to select a mutual fund is to review the underlying fundamentals.
For example, say you’ve researched the home building sector and have concluded that the prospects for near-term appreciation are excellent. In that case, you may be comfortable with the front-loaded fees of a Class A fund, if you believe that the fund’s appreciation in the near term will far outpace the cost.
Likewise, it’s never a good idea to buy mutual funds solely because the fees are low or favorably structured. A dog of an investment is still a dog if it’s cheap, and you’ll never be able to make up for the lost income in fees saved.
The trick is that in the mutual fund world, you’ll find all sorts of combinations: expensive funds generating strong returns and others that are lagging the market. You’ll see some lower-priced funds that are enjoying accelerated growth and others that are skimming the bottom.
That’s why the decision to buy Class A, B or C is a highly individual choice and depends both on the perceived strength of the investment and your own time frame. Research the funds first, and then consider how different fee structures will impact your earnings.
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