ABCs of mutual-fund share classes
By Laura Bruce • Bankrate.com

Once upon a time, mutual-fund investors had to decide between no-load funds and funds that charged a front-end load, which is an upfront sales charge or commission.

These days, there are a variety of mutual-fund share classes that can complicate the buying process. Investors can often choose to pay the sales charge on the front end or the back end or, perhaps, opt for a so-called "level" load.

No-loads are funds you can buy without paying a commission. When you buy directly from the fund company, you don't pay a load. You can also buy no-load funds from a fund supermarket such as Fidelity, but you may have to pay a transaction fee.

You can find no-load funds for just about every asset class -- small-cap growth, large-cap value, etc. They are quite often the better buy, giving you a higher return on your investment. However, there are plenty of times when investors or their investment advisers latch onto a fund that charges a commission, and those funds have letters that describe the fund's load structure.

Before we delve into that, it's important to understand that all mutual funds charge shareholders fees and expenses. There are fund-operating expenses such as the management fee that every shareholder pays. Many funds charge a 12b-1 fee, which is supposed to cover marketing and distribution costs. Investors don't pay these fees directly. If you invest $10,000 in a fund, all of it may be used to buy shares. But when it comes time for the fund to deduct its fees and expenses, the money comes out of the net asset value, the share price.

Some people say share classes are simply creative ways for fund companies to wring more money out of investors. Others say the different classes allow investors to choose how to pay the loads and fees associated with their investment.

The most common share classes are A, B and C, but there's an alphabet soup. You may find I shares -- usually "institutional," but sometimes "investor." You may see M or Y shares, or H or T.

"The letters are subjective, a fund company can give any letter or class to any fund," says Lucas Garland, research analyst at Lipper, a mutual-fund research company.

"Not all A classes are front-end load. Y and M are usually one of those three (A, B or C), but they could be institutional classes and they could be no-load. It's safer to call a fund by its load structure rather than by letters."

The most common share classes
That's solid advice to keep in mind when researching mutual-fund investments. But for the sake of simplicity within this story, we'll work with the most-common letters and the most-common definitions of the three share classes mutual-fund investors see most often.

Class A shares: Typically have a front-end sales charge, according to the National Association of Securities Dealers. The sales charge is taken out of your initial investment. If you pay $10,000 for a fund that has a 5.75 percent front-end sales charge, $575 goes to the sales charge, or commission, and $9,425 is used to buy shares.

Class A shares may also impose a 12b-1 fee for annual marketing and distribution expenses, but it's usually fairly low, about 0.25 percent.

Class B shares: The commission is back-end loaded on these funds. It's often referred to as a "contingent deferred sales charge" because it's based on how long you hold your shares and how well the fund did. Say the fund charges a 5 percent sales charge when you sell the fund. (That would be 5 percent of your account balance, not your initial investment.) Typically, the fee decreases by 1 percent each year you own the fund until it disappears. The caution here is that sometimes the fee takes six or seven years to evaporate. Some brokers call these shares no-load. They're only no-load if you hold the fund the required amount of time.

Another catch is that these funds often charge a higher 12b-1 fee, perhaps 1 percent annually. But a benefit for long-term holders is that class-B shares often revert to class-A shares after the contingent deferred sales-charge period ends. You would then start paying the usually lower 12b-1 fee of 0.25 percent.

Class C shares: These are level-load shares. Usually, not always, there's no front-end or back-end sales charge. But typically there is a 1 percent 12b-1 fee for as long as you own the fund. These shares do not revert to class A shares, so they can be very expensive if you plan on holding the fund for a long time.