ABCs of Fund Fees

After years of creating new kinds of commissions for the brokers who sell them, some mutual funds now resemble a vat of alphabet soup cooked up by a character out of Dr. Seuss. There are A shares, B shares and C shares, not to mention D shares, I shares, Y shares and Z shares — all collecting different fees in different ways.

A few brokerages, lately including Prudential Securities, have been slapped by regulators for steering investors into funds that charge inappropriate fees (or "sales loads," in fundspeak). The National Association of Securities Dealers, which regulates such matters, recently reminded brokers of their obligation to charge fund investors fair fees. But what exactly is fair and appropriate?

Most investors would be better off in no-load index funds, which charge no sales commission and cut the costs of investing to the bone. But if you work with a broker for investing guidance, as millions do, you can't expect her to work for free, so a no-load index fund won't be on the menu. Unfortunately, with many brokers, the menu is dominated by that funky alphabet soup. A shares carry a sales charge, typically 4.5% to 5.75%, that you pay your broker when you buy. B shares charge nothing when you buy but nick you for as much as 6% if you sell in the first six to eight years. C shares usually charge nothing when you buy or sell but whack you with fat annual fees of nearly 2% the whole time you own them.

If you're a long-term investor, the up-front A shares are cheapest. Wake Forest economist Edward O'Neal has proved that over a period of more than seven years, no other load structure can outperform A shares. And if you invest $25,000 or more, most load funds will give you a discount on the up-front sales charge — making A shares the best choice even in the short run. Those discounts, which are not available on B or C shares, are called breakpoints.

Sadly, you can't always rely on your broker to make the best choices for you. In a new survey by business professors Michael Jones and Vance Lesseig of the University of Tennessee at Chattanooga and Thomas Smythe of Furman University, just over half of the 530 brokers queried said they would recommend B shares for short-term investors, while 53% favored B and C shares for clients with more than $25,000 to invest. Smythe calls this "very disturbing evidence" that brokers are either as fee-befuddled as their clients — or blatantly self-serving. I call it proof that the only investing watchdog you can rely on is yourself. Here's how to avoid a load of trouble:

KNOW YOUR INVESTING HORIZON. If you own a load fund for at least seven years, nothing but A shares makes sense. C shares are generally better for holding seven years or less. B shares might be the cheapest option for a seven-year horizon, but they aren't economical for any other time frame.

PUSH FOR DISCOUNTS. Find out how much you must invest to qualify for a fund's breakpoint. Visit the company's website, and have your broker show you the "sales charges" section of the fund's Statement of Additional Information (SAI). If you already own the same fund in your 401(k) or IRA, that money may count toward the cut rate. If other members of your family hold funds from the same company — or plan to do so over the next 12 months — you could qualify for a discount on a fund's A shares.

DON'T BE BASHFUL. What if your broker still tries to nudge you into B or C shares? Remind him that he is required by investing regulators to show you — with real numbers — why that choice would be in your best interest, not just his.