For mutual funds investors, deferred sales charges (also known as “back-end fees”) can cause a lot of headache when investors come to realize that their investments are essentially locked-in by deferred sales charge (DSC).
The following information is based on what I wrote as an original article for the Globe and Mail.
What is a Deferred Sales Charge (DSC)?
The DSC is a fee that gets charged to a client (5-6% in year 1, declining to 0% in years 6-7) if they sell a mutual fund without transferring it to another mutual fund from the same company.
How DSCs started
Canadian mutual fund executives pay stock brokers or mutual fund salespersons and their companies a 5% up-front fee. The problem is if a client decides to move the assets out of the fund family, the mutual fund company needs to recover this commission already paid out.
It does this by having the client pay the DSC commission fee, which can be large if they leave the fund in the first few years. In many cases, clients keep their money invested with the same fund family solely to avoid paying this fee.
Mutual fund sellers claim that these fees are supposed to encourage people to “buy and hold” for a longer time. However, if somebody is not getting the level of return they would like, this just traps people to stay with the same fund company. Investors might be interested in “buying and holding” but with a different fund; the DSC fee effectively prevents this.
As a consumer, the solution is simple: watch out for DSC fees. If you want to invest in mutual funds, learn about the different mutual fund fees first and consider your options (including low-load or no-load funds that do not have DSC fees).
There are many steps that regulators could take. The best would be to make the adviser pay the DSC if a client leaves early. By putting the adviser on the hook, you can be certain that far fewer of them would sell funds on a DSC basis.
Regulators can make all of the requirements for full disclosure and signatures that they want – and they should – but until you make the adviser pay, there will still be a strong incentive for stock brokers and mutual fund salespeople to sell mutual funds with a DSC.
An alternative to mutual fund investments can be segregated funds. Read this short, informative post about the benefits of investing in segregated funds.
At TriDelta Financial we help our clients to invest intelligently, tax efficiently and never with DSCs. If you want to learn more about how we can help, contact me at 1-888-816-8927 x221 or email me at email@example.com
Ted Rechtshaffen MBA, CFP