Mutual Funds

The Confused Mutual Fund Investor

With so many options for investing, concerns over who to trust and the lack of useful information from the mutual funds themselves, understanding the principles of growing money and good guidance makes a huge difference in outcome.

It’s important for an investor to understand the mutual fund industry; specifically, to understand what this means to him or her individually. The mutual fund industry has really created a giant that is so overwhelming and confusing for the average investor that they almost fall down to their knees and say “Uncle.” In this article, I’ll show how this confusion happens. 

There are some choices that you have when you invest: You can buy a growth fund, you can buy a growth and income fund, you can buy an income fund, you can buy an aggressive growth fund, a large cap growth fund, a mid cap growth fund, a small cap growth cap fund, a small cap international growth fund, a stable income fund, a large cap value fund, an international value fund, a target maturity fund, a blended fund. Of all those target maturity funds, you can by a 10, a 15, a 20, a 25, a 20-30 target maturity fund. Then there are blended funds, specialty funds, which could be in real estate or commodities or technology or health care or utilities or energy or green energy or social responsibility funds. And this is nowhere near exhausting the list. No wonder investors get confused. 

The average investor works eight hours a day, then has to tend to personal matters, family, home, etc. Maybe they get some recreational time if they’re lucky. And if they’re really, really lucky, they get to see a friend once a month, and maybe spend time with their spouse or partner if they have the time. Is it any wonder that investors turn to financial advisors or just kind of throw their hands up and say, “I — I really don’t know. Just give me something. Make it clear. Better yet, you do it Mr. Financial Advisor.” 

Some mutual fund companies have as many as 300 mutual funds, plus even more choices and confusing explanations on top of that. By presenting you with something called share class (or share type), the mutual fund industry makes investing even more overwhelming. Makes one wonder, is the object to invest or to confuse?

Here is very brief history on share class. It was rule 18F-3, it came out in 1995, and basically what this allowed was the mutual fund industry to come out with different types of share classes. At one of the largest fund families in the world, there are 14 different classes of shares. 

Here are a couple of examples: You can buy Class A, which is a front-end load that has a fee anywhere from 3-6%. You can get a Class B, which has no front-end load, but it has a 12B-1 fee, which is a marketing fee which will be there for 5 years. The broker who sells this fund to you gets that 12B-1 fee all up front, all 5 years of it, which is about equal to the front-end load that the investor thought he or she was getting away from. It’s actually a sales commission. If the investor sells these shares before the 5-year period, the balance of the deferred sales fee is deducted from the sale. 

Another example: The Class C share, which keeps the 12B-1 fee forever. The fee never goes away. 75% of those fees go to the financial advisor who sold the stock to the client. Now, these Class C shares are the favorites of financial advisors, because a financial advisor usually does not have a license to offer Class B shares, so they can’t collect fees as they can on C shares; hence, they sell Class C shares to their clients. 

The financial advisor will say to his or her clients, “Just so you know, I get paid from the mutual fund; but you’d have to pay those fees anyway.” This is not true, because there is a share class where there are no fees, there are no front ends, back ends, side ends, or 12B-1 fees on them. So they really aren’t being entirely honest with you.

Then there are Class D shares, which are sold through the supermarket funds, like Schwab, Fidelity, or Ameritrade; Class S shares and Class Z shares, which are closed to new investors; Class I shares and Class Y shares and so on. The average investor can quickly become confused about options and differences between funds and Class A, B, C, D, S and Z shares, and the different ways the 12B-1 fees apply. When all the different types of shares and mutual funds that are being offered are added up, there are about 100,000 and growing different products to choose from. This excludes stocks, bonds, exchange-traded funds or exchange-traded notes or closed end.

Conventional wisdom says that brokers should know more than their clients and have their best interest as first priority. But to do so, they have to first get good information themselves; and if the industry, as well as the companies they work for, are conflicted regarding the client’s best interest, this can cause dangerous (to your money) and expensive problems.

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