By JLP | April 29, 2010
Since I have been on the topic of mutual funds, I thought it would be interesting to look at the difference between an A-Share mutual fund and a c-share mutual fund. Since I already have the data from my other posts, I’ll use American Funds Investment Company of America to make my comparison.
For those of you not familiar, an a-share mutual fund is a front-load mutual fund. That means when you purchase an a-share, a percentage (usually around 5%) of your purchase goes to pay the front-load. The more money you invest, the smaller the front-load is as a percentage (called breakpoints). For instance, ICA’s maximum load is 5.75%. But, if you invest $100,000, your load is reduced to 4.5%. A-share mutual funds also charge a 12b-1 fee (also called a trail) that is used to compensate the broker. The 12b-1 fee for the ICA a-share is .23% per year.
A c-share is much different. There is no front-load but in order to compensate the broker, the fund charges a higher 12b-1 fee. In the case of the ICA c-share, the 12b-1 fee is 1%. This 1% is charged for as long as you own the fund. There also are no breakpoints for investing more money in the fund.
As you can probably imagine, the c-share ends up being more expensive to own over the long-run. But, that doesn’t necessarily make it a bad product. Why?
Well, when a broker is making 1% per year, there is an incentive for him (or her) to take care of the client. As their c-share business grows, there’s also less pressure for the broker to have to find new clients. Contrast that to an a-share that pays a big commission up-front. As soon as the broker earns that commission, they have to either pursue more money through that client or they have to go out and find more clients so they can earn more up-front commissions. There’s not nearly as much incentive to take care of the existing client. Sure, not all brokers work this way but some do and it is a risk of purchasing an a-share mutual fund.
So, let’s look at a numbers comparison of ICA’s a-shares and c-shares. The ICA c-shares have only been around since 2001. I like to look at round numbers so I began the comparison on December 31, 2001 through December 31, 2009. I assumed that the 12b-1 fees (I divided the annual 12b-1 fee by 4) were charged on a quarterly basis based on the account value on the last day of each quarter. Here are the results I got:
It’s not a lot of difference but keep in mind that this was for only 7 year’s worth of data. The gap will grow with time (assuming all else stays equal). Most brokers I knew NEVER sold c-shares because they needed the big up-front commission and didn’t want to take the risk of the client leaving before they could make up the lost up-front commission in trailing commissions.