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Jim Maroney

:: Mutual fund investing comes at a cost … upfront and backend sales charges that can reduce your real return on investment (ROI)

:: At its most basic level, mutual fund investing is really quite simple – a large group of people, with more or less the same investment objective, contribute money to a “fund” that pays a professional manager to purchase and otherwise manage a variety of investments on behalf of the fund. Investors, particularly small investors, are thought to benefit by achieving broader diversification than they could on their own while tapping into the superior returns achieved by expert management. This all sounds fine and dandy but mutual fund investing comes at a cost.

The first cost mutual fund investors are likely to encounter arises at the time of purchase. Investors are usually given a choice in how this cost, known as a “sales charge”, is paid. In simple black and white, investors can choose to pay the sales charge at the time of purchase or at a future date when the mutual fund units are sold.

The upfront sales charge is generally referred to as a front-end load in mutual fund lingo. Front-end loads are deducted from the amount invested and paid to your financial advisor as a commission. Say, for example, you decide to invest $1,000 and pay a front-end load – the actual amount of your investment will be something less than $1,000 because part of this amount will be used to pay for the front-end load.

The size of a front-end load can vary depending on the type of fund, the amount invested and other factors. For example, AIC charges 6 per cent of the amount invested ($60 per $1,000) for its regular mutual funds and 3 per cent for money market funds. CI Funds, use a front-end load that varies depending on the amount invested – 5 per cent for investments under $25,000 declining to 1 per cent for investments of $250,000 or more.

The key point to understand about front-end loads is that they are negotiable – don’t mistakenly assume that front-end loads are cast in stone. To be clear here, the negotiations I’m referring to are with your financial advisor and not the mutual fund itself. That’s the good news. However, as is often the case, money talks – the more money you have to invest, the more clout you have and the greater the likelihood you’ll be successful at reducing or eliminating a front-end load.

A sales charge paid at some future date is commonly referred to as a deferred sales charge or a redemption fee.

If you choose to pay a sales charge in this manner you will pay a fee based on the number of years you held the fund. Generally, the deferred sales charge fees are 6 per cent in the first year declining by one-half a per cent each year reaching 3.5 per cent in year six with no fee charged in year seven and thereafter.

A critical issue to be aware of is the base to which this percentage is applied – is the fee calculated on the original purchase cost or the net asset value of the fund at the time of redemption? If the calculation base is the original cost, you will have certainty in calculating the amount of the deferred sales charge projecting into the future. On the other hand, if the calculation base is net asset value at redemption, the size of the deferred sales charge will vary in accordance with variations in the value of the fund during the time of ownership. If, for example, the value of the fund rises in a given year the nominal amount of the deferred sales charge could actually be higher than an earlier year despite a drop in the applicable rate.

Some funds (CI Funds for example) provide a free redemption right wherein investors are given an opportunity each year to redeem a certain number of mutual fund units without charge. In the case of CI Funds the number of mutual fund units that can be redeemed is determined by formula.

Unlike the front-end sales charge, deferred sales charges are not typically negotiable – your sales charge will be calculated using the stated rate in the year of redemption, end of story.

Deciding whether to pay a front-end sales charge or a deferred sales charge is tricky business. If you don’t like the idea of feeling tied to a particular fund or family of funds and you want the flexibility to get out of a fund when you choose, then a front-end sales charge may be to your liking. Remember though that paying front-end sales charges every time you buy a fund can be costly – the trading freedom a front-end load provides is not unfettered. Furthermore, because front-end sales charges are taken off the top, they reduce the number of units your money can purchase in comparison to the deferred sales option.

On the other hand, if you’re looking at long time horizon and you’re not the type who spends night after night worrying about fund performance, a deferred sales charge may be your best bet. A further benefit of the deferred sales charge is the fact 100 per cent of the amount you invest is applied to purchase fund units – nothing is immediately lost to sales charges.

Finally, although this article has covered mutual fund sales charges, it’s worth noting that there are mutual funds out there that do not assess any sales charge at all. These funds, referred to as no-load funds, are offered by each of Canada’s big banks among others.

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Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney
CA Canadian Chartered Accountant with Brown, Andrews & Maroney in Maple Ridge, BC, Canada

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