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Dividend University

Understanding Mutual Fund Share Classes

Building a total portfolio can be a complex endeavor. Juggling multiple asset classes and positions can leave many investors feeling overwhelmed. There can be something said for keeping it simple. This is especially true for dividend stock investors and income seekers. Under that guise, this could mean buying a broad dividend/equity-income mutual fund.

And there are plenty of reasons why that strategy makes sense.

For one thing, dividend-focused mutual funds allow for plenty of diversification, which makes it easy to own multiple dividend stocks within one ticker. Secondly, the initial capital needed to start dividend investing is much lower than if you were to build out a portfolio individually. Finally, dividend mutual funds allow investors to tap into the knowledge of professional managers.

However, despite the overall simplicity of using a mutual fund, there is one major pitfall – selecting the right share class.

While many mutual funds carry a one-size fits all moniker, that’s not true for all of them. Many funds come with their own mix of one-time expenses, tickers and operating costs. Choosing the wrong share class for your mutual fund could have some negative effects on your performance over both the short- and long-term. Understanding share classes is not hard, but it is critical.

Multiple Paths to Ownership

The basic framework of a mutual fund is that it allows a group of investors to pool their capital together in order to buy assets. When you buy a share of a mutual fund, you have an ownership stake in the pool. The thing is, gaining access to the assets isn’t the same for everybody and it depends on what class you choose. Every share class owns the same underlying asset, but each comes with a different set of fees, initial minimums and potential sales loads.

The reason for the multiple shares classes stems from rules and regulatory actions by the Security and Exchange Commission (SEC). Rules 12b-1 and 18f-3 created the standardization we see today across mutual fund providers.

And because of those rules, most mutual funds have around four share classes. However, some could have as many as 17!

Find out more about share class evolution here.

First off is Class A shares. These come with sales charges called front-end loads. Typically, this fee is between 2.5% and 5.75% and is taken off when the shares are first purchased. Class B shares also charge a sales load. However, it’s on the back-end when shares are sold and drop lower the longer you hold them. Class C shares are known as level-load funds. They do not charge a front- or back-end sales load. However, they do lever an extra charge, typically 1%, every year of fund ownership. And, finally, for those investors with a large sum of money – normally $500,000 or more – there are Class I or Institutional shares. Investors in these shares are rewarded with some of the lowest expense ratios around.

A Real-World Dividend Fund Example

Using a real-world example, we can see how the alphabet soup of share classes plays out. Suppose you’ve decided to use a dividend mutual fund in your portfolio and you’re drawn to the top-ranked BlackRock Equity Dividend Fund. But, as we said, there are many ways to access the fund – seven different ways, in fact.

The Institutional shares (MADVX ), which has been labeled as the Primary Share Class for the fund, offers a 0.73% expense ratio and no sales loads. However, MADVX does require a $2 million initial investment. Class A Shares (MDDVX ) comes with a lower initial investment of only $1,000. However, fees are higher with a 0.98% expense ratio and a 5.25% front-end sales load. Finally, Class C shares (MCDVX ) comes with a steady 1.68% expense ratio and no sales load. The other three classes are available only to certain retirement plans or other sponsors.

Given the different loads and fees of the various share classes for the BlackRock fund, you get a different return profile – with MADVX leading the way.

The Bottom Line

Dividend mutual funds make a lot of sense for many investors. But navigating them can be a complex endeavor given multiple share classes. Understanding what you’re buying is critical to crafting your ideal portfolio. Making bad mutual fund choices could result in lower returns, higher expenses and missing your ultimate goals.