What is a B-share mutual fund?
B-share mutual funds have sales charges as high as A-shares, but they hit in a less obvious fashion. For years, reps faced resistance from prospective clients who objected to the immediate loss of money after purchasing front-loaded A-shares. Promoting investments guaranteeing a substantial loss on day one is a hard sale. B-shares were designed to overcome the visibility of this defect, though not the defect itself.
To pay the sales folks, B-shares add a charge to the fund’s other expenses, taking a little bit every day for commissions. A 6% load might be collected at the rate of 1% per year for six years, or 0.75% for eight years, or some other pace and length that strips at least 6%. To ensure the whole commission gets collected, B-shares add a back-end penalty. If a B-share owner sells shares before the entire sales fee has been paid, the proceeds from the share liquidation are reduced by an amount roughly equal to the uncollected commissions. A typical back-end penalty structure might stipulate a 6% charge the first year of ownership, a 5% charge the second year, a 4% hit the third year and so on until the penalty disappears in year seven.
Why you should avoid B-share mutual funds
High annual charges
Just like other mutual funds, B-share funds incur management and administrative expenses. B-share commissions known as 12b-1 fees are added to this, creating a huge total expense ratio. It is not uncommon for annual B-share fees to amount to 2% or more. This can completely wipe out the returns of many bond funds and it’s a major hit to stock returns as well. The commission drainage eventually ends, often after six or seven years. But it starts again on newly deposited money and re-invested dividends.
Back-end penalties
B-shares come with contingent back-end fees that hit if shares are sold during the first several years. This charge assures commissions for the sales team. These charges damage your wealth and create disincentives to moving money. There may be times you want to sell a particular investment. You may need cash for a large purchase or unexpected life change. Perhaps your risk profile shifts to a different asset allocation. Whatever your needs, you should always be able to access your own money. If you buy B-shares you will never recover all of it, and you will be disinclined to touch it at all, even for beneficial reasons.
Growing harm
As with A-shares, B-share fee damage worsens over time. Assuming a 1%, 7-year commission schedule and S&P 500 index returns, a $50,000 investment in a B-share stock fund from 1998 to 2017 would have forfeited over $13,000 in earnings obtainable with a no-load fund identically invested. An investment grade B-share bond fund would have sacrificed about 18% of the returns obtainable in a no-load equivalent during the same period.
What you should do instead
B-share funds are often the cornerstone of terrible retirement plans, such as corporate 401k plans. If you see B-share funds in your plan, speak with the person who determines your firm’s benefits and request a change of providers.
If you’re personally considering buying a B-share fund as the major component of your entire investment plan, click here for a simple, proper investment regimen.
If you are considering a ‘B’ share fund to satisfy a specific exposure, search for a low-cost no-load fund with similar exposure. You can use fund screening tools found at Morningstar.com and good institutions like Schwab and TD Ameritrade. Minimize your expenses, perhaps with an index fund in the category sought. If your institution does not provide free access to low cost index funds, change institutions.
If you’ve already purchased a B-share fund and are concerned about the back-end penalties, ignore the concern. The back-end penalties effective at any given time are usually about equal to the remaining commissions yet to be collected going forward. You’re already contractually committed to paying the sales charges. Move forward now and get into no-load products that better serve your needs.
* Data sources:
Stock returns: S&P Dow Jones Indices LLC; Standard & Poor’s 500 Index.
Bond returns: Federal Reserve Release H-15; An index of equal parts (25% each) Moody’s Aaa corporate bonds, Moody’s Baa corporate bonds, 5-year Treasury bonds, and 10-year Treasury bonds, rebalanced annually.
Fund expense rate: 0.2%
Loaded B-share sales charge: 1% per year for seven years.