The “Hidden” Sales Charge

June 17, 2015

I received a call recently from an investor that was a little confused about differences in mutual fund share classes. It seems this individual opened an IRA with a financial advisor a few years ago and purchased an “A” share mutual fund. Then, just a few days ago, they received a letter from the custodian informing them that “B” shares would no longer be available for purchase. The investor had never heard of a “B” share and wasn’t quite sure what this meant, so they decided to call the Financial Helpline.

Quite simply, when an investor purchases an A or B share mutual fund, they are paying sales charges that are used to compensate the financial advisor. The sales charges may include an initial upfront charge (A share), or a deferred back-end charge (B share). In addition, each share class charges an annual expense that compensates the advisor on an ongoing basis.

Now there’s nothing wrong with paying a sales charge on a mutual fund. Like all professionals, financial advisors deserve to be paid for the services they provide but as an investor, you should fully understand how each share class works so that you can choose the one that is most appropriate for you. (Not all advisors are compensated the same way, so ask your advisor how they are compensated if you are not sure.

After explaining the differences in the share classes, this caller asked if they could see the sales charge on their monthly statement. Unfortunately, the mutual fund industry has made it very difficult to actually see the charges you are paying. In the case of an A share, the sales charge will not show up as a line item on your monthly statement but rather will be reflected in the difference in the price you pay for your mutual fund (called the public offering price or POP) and the price at which you can sell your mutual fund (called the net asset value or NAV).

Let’s say you want to buy the A share class of the XYZ mutual fund which has a 3% upfront sales charge. If the the POP (the price you pay for it) is $100/share, the NAV (the price you can sell it for) is $97/share. As you can see, if you purchased one share of XYZ for $100 and immediately turned around and sell it for $97, the $3 difference would represent the 3% sales charge on your $100 investment. This is just one hypothetical illustration, and there are others, but that’s why you won’t see a sales charge listed on your statement.

Since sales charges and other fees reduce your returns, you may want to ask your advisor if they offer mutual funds with less expensive share classes or investment styles. (In fact, the higher annual expenses of funds with an active management style can easily add up to more than the sales charge over time.) If not, consider a different advisor.