You have to be careful in the supermarket cookie aisle. If you’re in a hurry and thoughtlessly grab a package of Oreos, you might get a rude surprise at home when you bite into an unexpected flavor from the company’s growing menu, such as peanut butter, birthday cake or lemon.
The need for vigilance is greater — and the stakes higher — when you’re shopping for mutual funds. Fund firms have a dizzying array of share classes for their funds. If you find a fund you like, you may have to decide which of its varieties is right for you. Different companies offer different options, but the share classes you might see include A, ADV, B, C, F, I, J, K, L, M, N, R, S, T, V, W, Y and Z.
Some classes and names are simply marketing ploys. Jensen Investment Management named its retail investor class “J” to reinforce the company’s name. Vanguard’s “Admiral” class is a nod to the HMS Vanguard, the British ship that inspired the firm’s name. And Karner Blue Capital named its only fund class “Butterfly” for the endangered Karner blue butterfly.
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Indeed, there is no standard for naming fund share classes. The labels can have different meanings from fund to fund. “Deciphering mutual fund share classes can be a time-consuming and overwhelming process for retail investors,” says Matthew Garasic, a fee-only financial adviser in Pittsburgh.
Fund share classes, in addition to having different rules about who can purchase them and varying minimum initial investments, usually charge different expense ratios. In some cases you could pay a separate sales charge, too. Those costs can add up. “The share class an investor chooses can have a long-term impact on wealth accumulation,” says Garasic.
To help you figure out which share class of any given mutual fund is right for you, we’ll break down common share classes and offer some guidelines to keep in mind as you shop for funds.
The main reason mutual fund companies create share classes is to pay the assorted middlemen that sell their funds, such as financial advisers, insurance companies, brokerage platforms and 401(k) plans, among others, says Eric Jacobson, a director of the research firm Morningstar.
The compensation for these intermediaries often comes out of the funds’ fees, hence the different share classes and their wide-ranging expense ratios. “It is all driven by dollars,” says Jacobson. The dividing lines between share classes boil down to three factors:
- Sales charges: In mutual fund speak, a “load” fund imposes a sales charge or commission when you buy or sell shares. Front-end-load classes, typically labeled “A” shares, levy a median toll of 4.25% when you purchase them. These shares are commonly sold through advisers, who pocket the load as a commission.
On the flip side, share classes with a back-end load, typically labeled “B” and “C,” can charge you on the way out, when you sell them. B and C share classes often have higher expense ratios than A shares. - Initial investment size: Share classes typically vary by initial minimum investment, too. Some are built for deep-pocketed investors, such as pension funds and retirement plans. These classes, often called Institutional or I shares, can require large initial deposits of $500,000 or more. In return, institutional shares typically have low expense ratios.
Some fund firms also offer a break on annual fees for individual investors who are willing to fork over heftier minimum initial investments. For instance, investors can buy the investor class of the Vanguard Wellington fund for an initial outlay of $3,000 and pay 0.25% in fees per year. But for an initial investment of $50,000, the fund’s Admiral share class charges 0.17% in annual fees. - Channel. Where you hold your fund shares — in a personal account or a 401(k), for example — or whether you use a financial adviser, may dictate the share class you own. In a 401(k) investment plan, you may be offered the I share class of T. Rowe Price Mid-Cap Growth. If your adviser purchases fund shares for you, they will likely be Advisor shares. But if you buy shares in the fund on your own, you’ll get the investor shares.
Every class charges a different expense ratio: Mid-Cap Growth Advisor charges 1.02% in annual fees, the investor share class charges 0.77%, and the I share class charges 0.63%.
In addition, each brokerage negotiates its own deal with fund firms, says Steve Sanders, executive vice president of marketing and product development at Interactive Brokers.*
Finally, some fund firms create share classes to sell on broker platforms. For example, although American Funds’ A shares are generally adviser-sold, the firm’s F-1 share class is open to anyone, without a sales charge, at online brokers such as Fidelity and Schwab. The F-1 shares typically sport a slightly higher expense ratio than the A shares, but the difference is small.
The best way to navigate this alphabet soup is to stick with funds that trade free of commissions and transaction fees at your online broker, such as those available from Schwab’s Mutual Fund OneSource, Fidelity’s FundsNetwork or E*Trade’s menu of funds.
If a fund is offered in a no-fee network, there’s usually just one share class available, so there’s no choosing required. And you won’t pay a front-end or back-end load. But you may pay the brokerage a short-term-trading fee if you turn around and sell the shares within 60 or 90 days, depending on the firm.
If you must pay a sales charge to buy a fund, opt for the share class with the lowest expense ratio, if a choice is available, and plan to hold the shares for the long haul. And consider checking the full list of your fund’s share classes to make sure you’re getting the best deal available to you.
Morningstar lists all the share classes of any given fund, including symbols, loads, expense ratios, investment minimums and purchase constraints (institutional, say). Just look up a fund, then scroll down the landing page to “Review Other Classes.”
The Fund Analyzer tool from the Financial Industry Regulatory Authority also lists each fund’s share classes and lets you compare up to three classes to see how their respective fee schedules may impact potential returns over time — three or 10 years, say, assuming a certain annualized return. However, you’ll have to check with your brokerage firm to find out which classes are available to you.
The complexity of mutual fund share classes may be one reason investors are flocking to exchange-traded funds. “All the different mutual fund share classes can create the perception of special deals for some people,” says Danan Kirby, a vice president at Ariel Investments. ETFs trade commission-free at most brokerages and charge all investors the same expense ratio. “Simplicity is beauty. Everyone gets the same deal,” says Kirby.
* A previous version of this article stated that Charles Schwab charged a load for the A class shares of the John Hanco*ck Regional Bank fund. A Schwab spokesperson says that its website failed to display a footnote that explains that it waives the sales charge.
Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you makehere.
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Based on the information provided in the article, it discusses the importance of understanding and choosing the right share class when investing in mutual funds. The article explains that mutual fund companies offer different share classes to pay intermediaries, such as financial advisers and brokerage platforms, who sell their funds. These share classes have different expense ratios, sales charges, and minimum initial investments. The article suggests that investors should consider factors such as sales charges, initial investment size, and where they hold their fund shares when choosing a share class.
To provide more detailed information on the concepts mentioned in the article, let's break them down into sections:
Share Classes and Naming Conventions
The article mentions that there is no standard for naming mutual fund share classes, and different companies use various naming conventions. Some share class names are simply marketing ploys, while others may have historical or symbolic significance. For example, Jensen Investment Management named its retail investor class "J" to reinforce the company's name, and Vanguard's "Admiral" class is a nod to the HMS Vanguard, the British ship that inspired the firm's name. Karner Blue Capital named its only fund class "Butterfly" after the endangered Karner blue butterfly. [[1]]
Sales Charges and Load Funds
In mutual fund terminology, a "load" fund refers to a fund that imposes a sales charge or commission when buying or selling shares. The article explains that front-end-load classes, typically labeled "A" shares, charge a sales commission when purchasing them, while back-end-load classes, labeled "B" and "C" shares, charge a fee when selling them. Front-end-load classes are commonly sold through advisers, who receive the load as a commission. B and C share classes often have higher expense ratios than A shares. [[1]]
Initial Investment Size and Institutional Shares
Share classes also vary by the minimum initial investment required. Some share classes, often called Institutional or I shares, are designed for institutional investors, such as pension funds and retirement plans, and require large initial deposits of $500,000 or more. In return, institutional shares typically have lower expense ratios. Some fund firms may offer lower annual fees for individual investors who are willing to make larger initial investments. For example, Vanguard offers an investor class with an initial outlay of $3,000 and an Admiral share class with an initial investment of $50,000, which charges lower annual fees. [[1]]
Channel and Share Class Selection
Where an investor holds their fund shares, such as in a personal account or a 401(k), and whether they use a financial adviser, may dictate the share class they own. For example, in a 401(k) investment plan, investors may be offered a specific share class, such as the I share class of a particular fund. If an adviser purchases fund shares for an investor, they will likely be Advisor shares. If an investor buys shares in a fund independently, they will typically get the investor shares. Each share class may have different expense ratios. [[1]]
Choosing the Right Share Class
The article suggests that investors should consider several factors when choosing a share class. If a fund charges a sales commission, investors should opt for the share class with the lowest expense ratio. Investors planning to hold shares for the long term should also consider the full list of a fund's share classes to ensure they are getting the best deal available to them. Tools such as Morningstar's Fund Analyzer and the Financial Industry Regulatory Authority's Fund Analyzer tool can help investors compare different share classes and their respective fee schedules. [[1]]
Exchange-Traded Funds (ETFs)
The article mentions that the complexity of mutual fund share classes may be one reason why investors are turning to exchange-traded funds (ETFs). Unlike mutual funds, ETFs trade commission-free at most brokerages and charge all investors the same expense ratio. This simplicity and uniformity may be appealing to investors. [[1]]
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