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Funds that cost you more
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November 14, 2000: 10:58 a.m. ET
Back-end -- or deferred -- sales charges on funds may be pricier than you think
By Staff Writer Jeanne Sahadi
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NEW YORK (CNNfn) - For mutual fund investors who are not load-averse but are cost-conscious, it may seem that back-end loads – or deferred sales charges -- are a better deal than front-end sales charges because you pay nothing to get into a fund. But, experts say, that isn't necessarily so.
True, "more of your assets are working for you than if you purchase a front-end load," said Burt Greenwald, a Philadelphia-based mutual fund consultant. That's because front-end charges are taken right off the top of your money before it is invested, which can make a big difference in terms of compounding if your fund is racking up 30 percent annual gains.
But with a back-end load, you likely will pay just as much if not more than your front-end load peers over the long-term.
The attraction
When you buy back-end load, or B-shares, you only pay the load -- or part of it -- if you pull the money out during the "penalty phase," which usually ends after the fourth, fifth or sixth year after your initial purchase.
 The longer you keep your money invested, the more your load is reduced. By the end of the penalty phase the load usually reaches zero, said mutual fund investment consultant Bill Dougherty, president of Kanon Bloch Carre.
So, if you leave your money invested for the full penalty phase, you won't pay a loaded dime, right?
Wrong.
You still pay top dollar
Investors in most B-shares pay far higher expense ratios on average -- between 73 cents and $1 more for every $100 invested in the fund, according to Morningstar -- than do shareholders in front-end loads or no-loads. And, remember, expense ratios are taken right off the top of your return.
Expenses are higher because fund companies charge owners of B-shares more for marketing and distribution costs, which are included in 12b-1 fees.
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 MEASURE YOUR EXPENSES
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The average expense ratio for a back-end load fund that carries a sales charge of 1 percent or more is 100 basis points higher than that of a no-load fund and 73 basis points higher than a front-end load fund with a sales charge of 1 percent or more. Source: Morningstar
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It works like this: When you buy back-end load shares from a broker, the broker gets an up-front fee on the sale from the fund company. The fund company, in turn, earns that money back from you over time, primarily through the higher 12b-1 fees, which are some percentage of your assets in the fund. The longer you stay invested, the more your money grows and the more they make in fees. That's why they can lessen the load you owe over time.
"A lot of people don't want to hear too many gory details," said Eric Jacobson, assistant director of fund analysis at Morningstar, but the bottom line is even if you stay invested through the penalty phase "when you buy a B-share you are still paying a load."
Ask about conversion
That doesn't necessarily put you at a disadvantage to your front-load paying peers if you invest for the long term.
Experts say the economic breakeven points of investing in either share class are likely to come together after five to seven years if your B-shares automatically convert to front-load shares at the end of the penalty phase, something many fund families will do for you. That means you will not be charged when you sell your shares and you will no longer have to pay as high a 12b-1 fee.
But some fund families may not convert B-shares. Eaton Vance, for instance, has only instituted B-share conversions for its more recently introduced funds. Or others, such as Merrill Lynch, make the conversion only after an investor has been in a fund for eight years, well past the penalty phase.
That means you need to read the fine print before committing yourself and calculate your expenses to the best of your ability.
Know your options
Of course, your time horizon will be a big factor in determining which share class makes the most economic sense for you.
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You're paying for it, believe me.
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Bill Dougherty
Kanon Bloch Carre |
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In terms of performance, a load fund worth buying as a front-load is often worth buying as a back-end load -- presuming you're investing for the long-term, Jacobson said.
In the short run, however, it can be pricier to be in a fund with a deferred sales charge, even though more of your money is allowed to compound from the start. "You're paying for it, believe me," Dougherty said.
If your time horizon does not exceed the penalty phase of a fund, Greenwald suggested that a "level" load, most commonly called a C-share, might make the most economic sense. That's because, while it carries high 12b-1 fees, it carries a much lower deferred sales charge than the B-share -- or none whatsoever -- and its penalty phase is usually shorter. The rub, however, is that the high fees associated with C-shares are permanent, making it a more expensive proposition long-term. 
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