By JACK HOUGH
Cash poured into mutual funds during the first week of February at the fastest pace in nearly two years, according to data from the Investment Company Institute, a trade group.
But not all fund investors are being treated equally. Two investors who buy into the same fund could end up with significantly different returns, due to a confusing array of share classes, each with a different fee structure.
As recently as 1989, the total number of share classes matched the number of funds: 2,262 in the U.S., not counting money-market funds, according to ICI data. By 2010 there were 6,928 U.S. funds available in 20,188 share classes.
"Most of these share classes weren't designed to help investors," says Mike Alfred, co-founder of Brightscope, which tracks retirement plans. "They were designed to pay someone else."
For example, the Amcap Fund, offered by American Funds, is available in A and C shares for all buyers, F-1 and F-2 shares for those who go through certain advisers and a handful of separate classes for investors who buy through a 529 college-savings plan.
A spokeswoman for American Funds says the purpose of different share classes is to allow investors to choose how they pay their adviser.
Most A, B and C share classes impose sales commissions, or "loads," based on the amount invested. Because loads pay salespeople, they are a needless expense for investors who choose their own funds or pay advisers directly, says Morningstar (MORN)
One way to get financial advice without sales charges is to find a planner who is paid by a set fee based on assets rather than a commission. The Financial Planning Association has a tool for that at FPAnet.org. Fees of 1% a year are common.
Even 1% can add up. For a 25-year-old who saves 9% of his pay in a typical stock and bond portfolio, the difference between paying, say, 0.25% a year and paying 1.25% amounts to having $510,000 or $410,000 by age 65, according to a study by Vanguard Group. A cheaper choice might be a planner who charges an hourly fee.
Some firms have fund marketplaces that allow investors to choose among hundreds of funds with simplified pricing. "We seek to have one and only one class of each fund," says Doug Hanson, who oversees the OneSource mutual-fund platform at Charles Schwab (SCHW)
Some marketplaces offer investors the ability to dodge loads. For example, A shares of the Federated Capital Appreciation fund cost a maximum of 5.5% up front through some channels, but the fee is waived for Schwab customers.
Just don't confuse "no load" with "bargain." That same Federated fund has ongoing expenses of 1.25% of assets per year. Princeton economist Burton Malkiel recommends mutual-fund buyers pay no more than 0.5% a year for an actively managed domestic fund, whatever the share class.
For investors who want a fund that comes only in A, B and C shares, deciding which class to choose is like deciding whether to rent or buy a house. Total future costs depend on unknowns, like holding periods and yearly returns.
A-class shares usually have hefty upfront fees, often 4% to 5.75%, and lower annual ones. Many offer discounts for larger purchases.
B shares usually have no upfront fees but higher ongoing ones, and impose a charge on holders who sell in the early years ("contingent deferred sales charge"). Typically, B shares convert to A shares after several years, thus shifting to lower ongoing expenses.
Over the past decade, the Financial Industry Regulatory Authority, or Finra, has stepped up enforcement actions against brokers for big-ticket sales of B shares that would have qualified for A-share discounts. Some mutual-fund companies have phased out B shares, including Fidelity Investments, Franklin Templeton and American Funds.
C shares also have high ongoing expenses. Minimum holding periods are short and charges for early sellers are modest. But C shares rarely convert to A shares, and thus stay expensive indefinitely.
It is possible to simplify the math. Finra offers a side-by-side comparison tool at Finra.org/fundanalyzer. For example, it shows that $10,000 placed in the Invesco S&P 500 Index fund, assuming it returns 5% a year for 10 years, will cost $1,269 with A shares and $1,630 with C shares.
The tool also shows that the similar Fidelity Spartan 500 Index fund, investor class, costs a good deal less: $115 under the same assumptions.
There is one last choice for people put off by share complexity: Buy individual stocks and bonds instead.
That is best left to experienced investors. But someone who can learn to analyze a contingent deferred sales charge probably has a head for telling whether Coca-Cola (KO)