Sales Charge: Types, Criticisms, Examples

What Is a Sales Charge?

A sales charge is a commission paid by investors on an investment in a mutual fund to the financial intermediary, such as a broker, financial planner, or investment advisor, responsible for effecting the transaction. This additional fee serves as compensation to the salesperson and is expressed as a percentage of the investment value.

Understanding Sales Charges

Many mutual funds have sales charges, which are quoted in percentages and equate to a portion of the investment. For investors, this means their actual investment in the fund is equal to the difference between the investment value per share and the total sales charge. By regulation, the maximum permitted sales charge is 8.5%, but most loads fall within a 3% to 6% range.

The level of sales charge an investor incurs often depends on the specific share classes of a fund. Charges can vary across different types of funds and share classes, and with some funds are not payable at all due to distributor relationships.

Investors should be sure that they clearly understand the sales charges and other fees associated with a fund. Fund companies typically provide comprehensive disclosure of their sales charges, including in their prospectuses.

It's worth remembering that sales charges do not factor into the gross and net expense ratio of a fund. That's because they are paid to financial intermediaries for their partnership in selling the fund, rather than to fund itself.

Types of Sales Charges

Some common types of sales charges include the following:

• Front-end sales charges are paid as a percentage of the purchase price at the time of the investment. Class A shares often have front-end sales charges.
• Back-end sales charges are paid as a percentage of the selling price at the time of sale. Back-end sales charges are often associated with B-shares of a fund.
• Deferred sales charges are back-end sales charges that decline over time, often eventually reaching zero. They are also called contingent deferred sales charges because the fee is contingent on the holding period.

Criticism of Sales Charges

Investor advocates and educators frequently criticize sales charges, with many arguing that they are entirely unnecessary for most investments today.

Sales charges take a bite out of investor returns, and they can be hard to spot. Some of the sales charges associated with B-shares are frequently condemned. For example, suppose that an investor intends to hold a mutual fund for many years and buys B-shares with deferred sales charges. The investor might ignore the sales charges because the desired holding period is long enough for them to go to zero. However, if an emergency arises and funds are needed ahead of schedule, the investor could be hit with a surprising sales charge of 5% or more.

Fortunately, sales charges can be avoided by investing in no-load mutual funds or exchange-traded funds (ETFs). It's important for investors to be aware, though, of the bid-ask spread on ETFs. A high bid-ask spread can be just as bad as a sales charge.

Examples of Sales Charges

Suppose that an investor puts $10,000 in the XYZ mutual fund with a front-end load of 5.75% for small investors. The investor’s actual investment in the fund after the sales charge would be $9,425. However, sales charges are only one of several types of fund fees that investors can reduce or eliminate.

In another case, an investor put $100,000 into the XYZ mutual fund. XYZ still has a front-end load of 5.75%, but they cut it to 4% for investments of $25,000 or more. They also reduce it to 2% for $100,000 or more, and to 1% for over $1,000,000. In this case, the investor's actual investment after the sales charge is $98,000. Notice that although the percentage has fallen, the total amount charged has increased.