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Day 6 - Investing in Mutual Funds
By JLP | February 7, 2006
Today’s topic in the 24 Days to Better Finances series is investing in mutual funds.
Mutual funds were one of the best things to happen for investors. Back when they were created, trading costs were high and company information was sparse. Therefore, mutual fund managers were very important people because they brought average citizens and companies together. Sure, mutual funds have been criticized lately and most of the criticism is warranted. However, for most people, mutual funds are still the best way for them to build wealth.
There are many different ways to invest in mutual funds. Most people probably invest in mutual funds through their company’s 401(k) or an IRA. A lot of people use a financial advisor or broker to purchase mutual funds. And, a lot of people invest in mutual funds on their own.
There are basically two types of mutual funds: load and no-load. Load funds are funds that are purchased through a broker or financial advisor. The advisor has to get paid for their services, which usually comes in the form of a load or sales charge. Here’s a look at the different ways loads are charged:
A-Shares - The most common form of load fund is the A-Share, which charges a front load that starts in the 5% range and decreases depending on how much money you have to invest (there is also an annual management expense which usually runs in the 1 - 1.5% range). If you invest $100,000 in an A-Share mutual fund with a 5% front-load, $5,000 will be used to compensate the broker and his firm and other $95,000 will go to work for you. This is a large sum of money but if you are working with an advisor you trust and you stay in the mutual fund for a long period of time (7-10 years), it can be an okay way to go.
B-Shares - With a B-Share mutual fund, there is no up-front charge. Rather, you are charged an increased annual management expense for the first 5 to 7 years, after which the B-share essentially becomes an A-share. Also, B-shares charges a contingent deferred sales charge (CDSC) during that same 5 to 7 year period. What this means is that if you sold the mutual fund during this period, a portion of your sales proceeds would go to pay this charge. The CDSC usually starts out at 5% for the first year and decreases by one percentage point each year after that.
C-Share - The C-share has no up-front load and no CDSC after the first year but have higher annual management expenses for as long as you own the fund. I like the C-share because it puts the advisor and the client on the same side of the table. Yes, the C-share would be more expensive in the long-run but you also have the assurance that the advisor will be working for you. You don’t get that same guarantee when you buy an A-share of B-share. Brokers are busy people. They have to continue to produce. Although they may get a nice up-front commission out of you when you buy an A or B share, who’s to say that they won’t forget about you in their quest to find more clients?
Other Share Classes - There are other share classes but most of them are used in retirement plans. Usually all they are is A-share mutual funds without the front-load.
No-Load Funds
No-load mutual funds are sold directly by the mutual fund company to investors. There usually are no brokers involved because no loads are charged. Brokers are fond of calling no-load mutual funds “no-help” mutual funds. Although no-load mutual funds do not charge sales loads, you still have to watch the management expenses, which can be quite high.
How to Buy Mutual Funds
As I said earlier, load funds are sold through full-service brokerage houses and insurance agencies. I’m talking about companies like Merrill Lynch, Smith Barney, UBS, and other full-service firms. To buy no-load mutual funds, you can go directly to the company like Vanguard or T. Rowe Price or you can purchase them through a discount broker like Charles Schwab or Scottrade. Most discount brokers have a list of mutual funds that you can buy without a sales charge. However, if you buy a mutual fund that isn’t on their list, you can expect to pay $17 or more depending on the firm. The advantage to using a discount broker is that you can get variety without the hassels of keeping up with different fund families.
That’s it. I think I pretty much covered the basics of mutual funds. If you have any questions, feel free to leave a comment. Now, here are some links to posts by other bloggers on the topic of investing in mutual funds:
MyMoneyBlog:
The Easy Vanguard Four Mutual Fund Portfolio
FreeMoneyFinance:
Fund Indexers, Take (Another) Bow
Don’t Give Up on Index Funds Yet
Ditching Expensive Funds Can Save You Serious Dough
Seven Sure Ways to Bigger Returns
BLOGGERS: As you can see, I don’t have a lot of entries for this topic. If you have anything about mutual funds, send me the links and I’ll be sure and add them.
Topics: Mutual Funds |