Many mutual fund companies assess an upfront sales charge known as a front-end load. It is charged as a percentage of the purchase price and the money is used to cover the broker's commission. Under federal securities laws, fund companies can impose a charge of up to 8.5 percent of the share purchase price. However, there are various ways to buy shares without having to pay an upfront charge.
Mutual fund companies sell various classes of shares. The front-end load is assessed only on A class shares. You pay nothing upfront when you buy B or C class shares, although you may pay a contingent deferred sales load or back-end load when you actually sell your shares. B shares have a decreasing load, which means the sales charge decreases every year. If you hold B shares for at least seven years, they convert to A shares and you do not have to pay anything when you sell your shares. Likewise, C shares often have a gradually decreasing back-end load, but they are not convertible. You may avoid the sales commission fee even if your shares do not convert to A shares.
Some mutual fund companies offer so-called no load funds. You do not pay a commission to buy or sell shares in these funds. However, you may pay purchase or redemption fees when you buy or sell shares in the fund. These fees are distinct from sales loads you pay on A, B or C shares, since sales loads cover brokers' commissions while purchase and redemption fees are administrative charges. In most instances, the purchase and redemption fees on no-load funds are flat and not based on the value of your shares.
You can reduce or eliminate front-end sales charges on A class shares by investing heavily in one mutual fund family. A family is a group of funds operated by the same investment company. Many companies offer discounted sales charges or breakpoints when your holdings in a particular fund family surpass a certain level. In some instances, you can get a price reduction if you write a letter of intent detailing your plans to buy additional shares in a particular fund within the next 13 months. Some fund companies waive sales charges altogether if your aggregate investment reaches a certain amount.
Aside from sales charges, mutual fund companies also charge management fees and distribution fees -- or 12b-1 fees. These fees cover their operating costs. Generally, these fees are higher on B and C shares than on A shares. The longer you hold the shares, the less cost-effective back-end load shares become. That is why the fund company must convert long-held B shares to A shares. Some no-load funds also have annual operating fees that are high when compared with A class shares. You may end up paying more in the long run if you choose to avoid paying a front-end sales charge.