The ABCs of Broker-Sold Funds

Brokers have several different ways to sell mutual funds to investors, all with one thing in common: They take money out of your pocket.

There's a good reason why no-load mutual funds are the best way to buy mutual funds -- they save you money. Historically, mutual funds that charge sales loads simply haven't been able to match their cheaper no-load counterparts. In fact, of the 100 top-performing funds of the past 10 years, more than three-fourths didn't charge a sales load.

But if you're working with a broker, you'll probably hear a sales pitch for a mutual fund. It's crucial for you to understand the fees and costs associated with various options of broker-sold funds before you buy.

Easy as A-B-C
Full-service brokers like Morgan Stanley (NYSE: MS  ) , Merrill Lynch (NYSE: MER  ) , and JPMorgan Chase (NYSE: JPM  ) sell mutual funds in several different classes. Generally, each class of a given fund buys the same investments with your money. But the class of fund shares you buy can greatly affect how much you pay in fees and expenses.

Class A fund shares, also known as "A shares," are what most people think of when discussing funds with sales loads. When you buy A shares, you pay an up-front sales charge based on how much you invest. For instance, if you buy A shares of a fund that charges a 5% load, every $1,000 you invest will result in only $950 in your fund account. The remaining $50 pays your broker's sales commission.

Another class of mutual fund shares -- "B shares" -- doesn't charge an up-front sales fee. But there's a trade-off: B shares usually come with higher annual fees, including 12b-1 fees that can go to compensate your broker. In addition, if you sell your shares within a certain number of years, you'll have to pay a deferred sales charge, which again can be as high as 5%. Once you've held them long enough -- typically 5-10 years -- B shares automatically convert to shares with lower costs.

Avoiding loads ... at a price
The prospect of paying a big sales load, either when you buy or when you sell, isn't very attractive to fund investors. That's why C shares became more popular in recent years, offering investors a way to reduce those charges substantially. In fact, many fund companies don't charge any loads at all on C shares.

However, the annual costs associated with C shares are much higher than A shares. You'll often see a 1% 12b-1 fee on top of the fund's normal expenses, which can total 2% or more. And unlike B shares, with their automatic conversion feature, you never stop paying those higher costs with C shares.

You may also find some other special types of shares. You'll sometimes see R-class shares in retirement plans; they can have 12b-1 fees that go to the people who sold the plan to your employer. Similarly, 529 plans can have special share classes that compensate brokers. All told, funds paid $11.8 billion in 12b-1 fees during 2006.

Just say no
Fund companies make millions with these fees. For instance, Franklin Templeton (NYSE: BEN  ) earned more than $277 million during its 2007 fiscal year on shareholder servicing fees, including 12b-1 fees. Blackrock (NYSE: BLK  ) earned $123 million last year on service-related revenues.

Yet with thousands of no-load funds available, there's really no reason why you need to buy a fund with any type of sales charge. If you're working with a broker, be careful. Even if you don't have to pay an up-front fee, you might still be paying more than you have to.

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