A Lesson in Mutual Fund Share Classes

by Petros 1. April 2012 17:00

One of the mutual fund industry’s dirty little secrets is that mutual funds with identical names, identical managers, and identical investment objectives are not identical.

Mutual funds can be sold in different share classes, where the principal difference among share classes are the fees and expense the fund will charge you.  In fact, it is common for a mutual fund to have some share classes that cost 100% or more than other competitively priced share classes.  Imagine buying a car at your local auto dealer and the sales agent tells you that two cars of identical make, model, condition, and options were priced at $20,000 and $40,000 respectively.  What would be your reaction?  Sadly, this is exactly what is happening in the mutual fund business.  More on that in a minute, but first a little background on mutual funds.

Mutual funds are collective pools of money, managed by professional investment managers.  The investment manager makes all investment decisions.  In fact, the only decision investors make is which investment manager they hire or fire.  Investors hire managers by purchasing mutual fund shares.  Investors fire managers by redeeming their mutual fund shares.  When a mutual fund is purchased, the investor’s money is transferred into the mutual fund pool.  Once in the pool, investment managers are in control and decide what to buy or sell (stocks, bonds, commodities, etc.).  When you fire an investment manager by redeeming your shares, the mutual fund company returns to you the proceeds.

Investment managers do not manage money for charity — they do so for a fee.  This fee is known as the mutual fund expense ratio.  The expense ratio is expressed as a percentage and reflects the mutual fund’s annual charge to investors.  Mutual funds generally calculate their fees daily, so a fund with an expense ratio of 2.00% may charge (2.00% / 365) against an investor’s balance each day.
Now let’s consider the effect of different share classes by looking at a real world example — the PIMCO Total Return Fund, managed by Bill Gross.  As of this writing, the PIMCO Total Return Fund is the largest mutual fund in the world, with over $250 billion in assets.  In fact, you may own this mutual fund in your Individual Retirement Account or 401k plan.  The PIMCO Total Return Fund is offered in a range of share classes:

  • Share Class A (PTTAX) – Expense Ratio: 0.90%, Minimum Initial Purchase: $1,000
  • Share Class B (PTTBX) – Expense Ratio: 1.65%, Minimum Initial Purchase: $1,000
  • Share Class C (PTTCX) – Expense Ratio: 1.65%, Minimum Initial Purchase: $1,000
  • Share Class D (PTTDX) – Expense Ratio: 0.75%, Minimum Initial Purchase: $1,000
  • Share Class P (PTTPX) – Expense Ratio: 0.56%, Minimum Initial Purchase: $1 Million
  • Share Class R (PTRRX) – Expense Ratio: 1.15%, Minimum Initial Purchase: None
  • Share Class Admin (PTRAX) – Expense Ratio: 0.71%, Minimum Initial Purchase: $1 Million
  • Share Class Instl (PTTRX) – Expense Ratio: 0.46%, Minimum Initial Purchase: $1 Million

The mutual fund objectives and the investment manager are identical, but the expenses vary significantly among the share classes.  Another significant difference among the share classes is the minimum initial purchase.  Mutual fund companies often reward large investors with more favorably priced share classes because they are purchasing in bulk.  It is similar to Costco selling bulk products for less than you pay at convenience stores.

What investors do not always know is that a better priced share class may be available.  The savings to investors can be significant, especially when considering that mutual funds are often purchased in retirement accounts with a buy-and-hold investment strategy.  Investors should do their homework before purchasing mutual funds, lest they risk spending more than necessary. If you would like to learn more or review your specific situation, our IRA Consultants are happy to assist. Alternatively, we welcome general questions or comments through our contact form.

Tags:

Investment Education | Mutual Funds

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