Making Sense of Share Classes

Question: There are so many different mutual fund share classes out there; how do I choose between them?

Answer: The mutual fund industry has seen a proliferation of share classes in recent years, and it's become increasingly difficult to discern the differences among them.

Essentially, share classes represent different ways fund companies "package" their product. The basic product is portfolio management, but there are other benefits that are included in the fees, such as advice, fees paid to the fund's other service providers (such as its custodian), shareholder services, and more.

Paying attention to share classes, and consequently how much you're paying in annual expenses, is important, because expenses directly impact the return your fund will achieve. But admittedly, the fund industry could help make that task simpler. In a recent article titled "Airing Out Fund Costs" that ran in the February/March issue of Morningstar Magazine, Paul Ellenbogen, director of Board Consulting Services for Morningstar Investment Management, called for greater clarity regarding fund share classes. "Even if investors can figure out what they are paying for, it's difficult to determine if they are getting a good deal relative to the fund's peer group or if they are getting overcharged," Ellenbogen writes.

Here is a rundown of the major share classes you are likely to encounter.

Load Fund Share Classes Some fund families like Franklin, Oppenheimer, and American Funds sell mutual funds through financial advisors; these are so-called "load" funds because an investor typically pays a front-end load at the time of the initial purchase. In this video from the 2015 Morningstar Investment Conference, longtime American Funds portfolio manager Rob Lovelace explains that American Funds sells its funds through financial advisors or planners because it wants people to not just get invested, but to stay invested. "Staying invested is often challenged by fear, and the more we can create systems to help people through those periods when the market is down so that they can stay invested is really important," Lovelace said.

And one might need a financial advisor's guidance to navigate the many share classes offered by the firm: American Funds offers as many as 16 separate share classes of the same fund. According to American Funds spokesman Tom Joyce, the firm offers so many different share classes because different structures suit different investor needs, such as how much one is investing, how long one expects to own the shares, and so on. "We want to have a number [of share classes] available for investors who are investing in different ways, and depending on how they want to pay for advice from their financial advisor," Joyce said.

Here are some of the share classes you would typically see offered by an "advisor-sold" or "load" fund shops like American Funds:

A Shares

A shares typically carry front-end sales charges, or loads, which come right off the top of your investment when you buy. For example,

B Shares

B shares typically carry deferred sales charges, often called back-end loads. Unlike the A shares, you won't pay anything upfront if you opt for the B shares, but you might pay a charge when you sell your shares, depending on how long you hold them. B shares have declined in popularity in recent years, and in fact, a number of firms have discontinued them. B shares usually aren't the most economical option, especially for long-term investors, because their expense ratios--the fees that you'll pay year in and year out--are usually far higher than expense ratios for the A share class. Returning to the Growth Fund of America example, you'll pay 1.41% in annual expenses for the

C Shares

You won't pay a front-end sales charge to buy C shares, commonly known as "level-load" shares, of a given fund. The maximum deferred sales charge you could be liable for--1.0%--is also much lower than it is for B shares, and it typically scales down much faster than the back-end loads of B shares. But C shares invariably have higher year-to-year expenses than do A shares, making them a bad bet for long-term investors. Growth Fund of America's

No-Load Fund Share Classes Other fund shops do not require investors to pay sales loads at the time of initial purchase. These fund shops include Vanguard, Fidelity, T. Rowe Price, and Dodge & Cox. In fact, Dodge & Cox offers just one share class for all investors in their funds, whether they are investing through a retail sales channel or in a retirement account. "We want to treat all of our investors the same from a fee perspective, and keep fees as low as possible," said Steve Gorski, a vice president at Dodge & Cox.

No-Load Shares The typical no-load fund doesn't carry any letters after its name, though no-load share classes are sometimes tagged as "retail" or "investor" shares. No-load means you won't have to pay a broker to buy and sell your shares--you can execute the transaction yourself, buying directly from the fund company or from a fund supermarket such as Schwab, E*Trade, or TD Ameritrade.

Note that a retail investor may pay a 12b-1 fee, which is a difficult-to-define fee that goes toward fund marketing and distribution. The fee is part of the fund’s overall annual expense ratio, and varies from 0.25% to 1% of fund assets (the fee is higher for B and C share classes).

Institutional Shares Many fund shops also offer institutional share classes of certain funds--often tagged as I or Y shares. Such offerings are usually only available to investors or institutions who invest large sums--usually $1 million or more--and have some of the lowest expenses in the mutual fund world (they typically do not charge 12b-1 fees). If you participate in a retirement plan at work and your employer is a good-sized company, there's a good chance you invest in the institutional share class of a given fund.

Retirement Shares

Retirement shares--sometimes tagged with an R after the fund name--are share classes that are explicitly created for retirement plans, such as 401(k)s. The fees that these funds charge range widely. Some R shares bundle in the record-keeping and other administrative costs associated with running the plan. For example, the

How to Decide If you buy and sell funds through a commission-based broker and have a long time horizon, chances are the A shares will be the most cost-effective for you. Discuss the amount you'd like to invest, your time horizon, and your goals with your advisor; all are important considerations when determining the most appropriate share class.

If you're investing a large sum, it's also worth inquiring to see if you're eligible for a discounted sales charge. These discounts--often called breakpoints--kick in when your total investment across the fund family reaches $25,000 or more. Even if you don't meet the minimum asset level yet, you may still be able to qualify for the discount if you sign a letter of intent that states you plan to invest enough money to qualify for the discount within a specified period of time (usually one year).

Last but not least, if you're using a commission-based broker, make sure that you're satisfied with the quality of advice you're receiving. Morningstar has tended to be agnostic on the issue of whether it's better to buy a load versus a no-load fund. No-load funds may be cheaper and don't have sales charges, but if you're receiving good advice, that may be worth the extra cost. If you don't want or need investment advice, you shouldn't buy the A, B, or C shares of a fund because you'll be paying for something (advice) you're not using.

A version of this article ran on Aug. 3, 2010.