Understanding American Funds Mutual Fund Share Class and Fees

Almost everyone who works full-time in the United States owns a mutual fund.  These funds sit in participants 401(k) hopefully doing some good.  Many times owners don't ever stop to look at those annoying prospectus pamphlets that come to our door... Don't worry, I am not going to say you have to!  Instead, make sure you know the key information about the mutual fund share classes and fees that are associated with them.  

Whether you are looking to get into the market or out of it these fees and tips are essential to long-term success.

Here's an example of what I mean. If you look up American Funds' "Growth Fund of America" I get the following different share classes:

A

A shares are front load mutual funds. If you look up this particular fund, then you will find that the front load for this share class is 5.75%. This means if I give my advisor a check for $1,000 my initial balance would reflect 94.25% of that $1,000 or $942.50. While this may seem like a lot you can lower this amount through break points. (We'll talk about them later.)

A shares have a lower expense ratio then other mutual fund share classes. This is essential for long-term growth. This particular fund and class has an expense ratio of 73 basis points or .73% per year.

B

B shares are back load mutual funds or funds with a back-end surrender or CDSC (contingent deferred sales charge) that is deducted if you liquidate the fund before the "surrender schedule" is finished. The tradeoff for not having to pay a front load in this instance is paying a higher management fee (1.45% for this fund). Make sure to know what it is before deciding to purchase this type of share class. For the most part, B shares eventually convert into A shares.

C

C shares have no front or back-end load fees. Instead they carry a higher management fee than other share classes (1.53% for this fund). These funds are generally used for shorter-term investors or those who aren't sure of whether they will need to access money in the next 3-5 years. Some fund families charge a fee of 1% if C shares are liquidated within the first year.

F

F class is for Fee based advisor. Through unbundled traditional fees the advisor then charges a fee with the investor that is agreed upon. The Expense Ratio still remains at .67%.

LW

LW stands for Load waived. A "Load Fee" is an upfront or back-end fee that an investor is charged for putting money into a mutual fund. If you own shares in a load-waived fund you are at an advantage because you are not required to pay these fees. There is a limit to the amount of load-waved funds that are available. For the most part retirement plans and institutional players have access to these funds. LW or A LW funds all have lower expense ratios when compared to other mutual fund share classes.

R

R Shares are within retirement plans. Because of economies of scale lower expense fees can be charged to larger 401(k)s and the resulting R-1, R-2, are a result of various 401(k) plans and the fees assigned to them based on their size and structure.

529

This just means that this particular class is held within a 529 savings plan. For the most part expense ratios for 529 plans are 5-10 basis points higher than traditional accounts. My guess is because 529 plans require a little more cost to account for than a traditional account.

So why does it matter which share class you purchase? Here is a comparison of the 3 using $100,000 over 20 years. Assume a 6% Interest Rate.

A Shares: .73% expense ratio, 3.5% Load Fee (See the American Funds Breakpoint Table)

C Shares: 1.53% expense ratio

Break Points

For A shares investors pay an upfront fee known as a load. Load fees in A shares can be reduced based on the amount that an investor invests. Using our example at American Funds, Investors pay between 0-5.75% for amounts ranging from less than $25,000 - $1,000,000+.

Rights of Accumulation

Rights of accumulation are established for what is considered a family account. This means that if you have an IRA, a 529, and a traditional account all at American funds, then those amounts can be added together to establish your breakpoint.

For Example.

Sally and Dave Smith establish 4 accounts at American Funds. Let's assume that the balances of each of their funds is the following:

Sally and Dave Smith JTWROS (Joint With Rights of Survivorship): $75,000

Sally Smith UTMA (Uniform Transfer to Minor Account): $15,000

Dave Smith IRA : $125,000

Sally Smith IRA: $25,000

In This example we would add these 4 accounts together to come up with $240,000. Based on American Funds Breakpoint Table, Dave and Sally would then pay a 3.5% front load fee until the next break point of $250,000 is established.

Statement or Letter of Intention

Let's suppose that Dave and Sally put that $240,000 to work for them all in one year. It seems somewhat unfair that they have to pay a front load fee of 1% higher than at the $250,000 breakpoint. Here's what they can do.

• First they need to let their financial advisor know that they plan on putting additional money into their account within the next 13 months. (This may vary between mutual fund companies so be sure you know what this time period is).
• Next they tell their financial advisor how much they plan to put into their accounts within the next13 months.

If the amount puts them above an additional breakpoint, then they will receive that breakpoint to begin with. On their initial $240,000 this could save them $2,400 in fees!

Additional Tips on Mutual Funds

Turnover Ratio

Turnover ratio is the amount of holdings that have been turned over in a mutual fund in a year.

When investing money in Non-Qualified Accounts (non-retirement) make sure to check out a funds turnover ratio.

Funds that are constantly turning over holdings will have a lot of short-term capital gains which are taxed to the investor at a higher rate (ordinary income) rather than long-term capital gains.

If you have a choice, leave those funds within your Qualified account!