Escaping the Deferred Sales Charge

Are you invested in DSC mutual funds? Remember, with DSC funds, commissions aren't charged up-front, but rather redemption fees are inflicted when the client leaves anywhere from o to 6 years after investing in the fund. The earlier you leave, the higher percentage in fees. Is it possible to get out without paying such redemption fees? Yes...

• 10% rule: Most mutual fund companies allow clients to redeem 10% of their holdings each year in a DSC fund or transfer amount into front-end load funds in the same family. This is a viable option, and it serves as beneficial to the advisor as their trailer fee (a fee they receive from the fund company for keeping their client invested with them) doubles for this portion of the portfolio.
• Another means of getting out of a fund is to switch into another fund in the same family. As the DSC clock goes on for 6 or 7 years (the period of which you'll be charged for leaving), make sure they don't reset the clock to zero. This is usually not a problem.

For both these approaches, there is no uniform method that mutual fund firms use. Please read their simplified prospectus for how they approach these rules.

Some clients, who are unaware of the downsides of the DSC, show a great deal of frustration with their advisor for subjecting them unnecessarily to such a compensation method. They....maybe, led to believe....that they are stuck, not just in the fund family, but with the advisor that entered them into such a model. This isn't the case, as the client can switch advisors.

This won't be as beneficial to the advisor accepting the portfolio, assuming there's no attempt to sell you out of DSC funds. With significantly lower trailer fees, they'll be taking a client with little compensation in the beginning. I think that speaks volumes for the advisor, who, by accepting the account, are counting on a long-term relationship. Respect, in my books. However, a client should be careful if a new advisor's suggestion is to sell everything and pay these redemption fees, especially if you haven't been invested in the DSC fund for long. This will more likely benefit the advisor than the client. Be skeptical of such a suggestion.

David Vs. the Deferred Sales Charge....

A deferred sales charge, or rear-end load fund, is a manner of investing in a mutual fund with a transaction-based (or commission-based) advisor in which there is no upfront fees charged but rather fees are charged when leaving the fund. The earlier you leave, the higher percentage that must be paid in redemption fees. "All your money goes to work for you," a financial advisor will say to make this compensation method more appealing.

It is my belief that there are very rare circumstances where it is the optimum fee choice for clients. In fact, I'll go even further and say that it is one of the most commonly abused tools in the retail investment industry. When qualifying advisors for Onus, their manner of approaching this compensation structure is a factor used to judge their practice. Forget recommending it, if they are presenting it as a viable alternative to the front-end load, when, many times, it is clearly not.... It simply is not good financial advice. With the exception of some extenuating circumstances (such as a problem with compulsive gambling or spending), it is not necessary for you to commit your money into an investment for as long as 7 years.

Due to its high upfront fee paid to the advisor from the fund company (as high as 5% for an equity fund), the advisor is being compensated far in advance for a service that hasn't been fully completed yet [funnily enough, the investment industry acknowledges this with trailer fees being cut by half]. It can create an atmosphere for negligence as they have been paid a strong chunk of their fees and penalties inflicted for leaving a fund family is more than enough incentive to get the client to stay. Thus allowing trailer fees to collect for the broker.

As our society gets increasingly more knowledgeable, the Deferred Sales Charge on mutual funds is being used less frequently. Ten years ago, it was a mainstream option used by a great many advisors. Today, to use it extensively does not exactly garner widespread respect.