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. Last Updated: 07/27/2016

Rear-Load Funds Bring Discipline Into Market

NEW YORK -- For the last couple of years, as investors threw hundreds of billions into stock mutual funds, many bought shares with "rear loads" from their brokers because they didn't want to reduce their investment by paying up-front commissions.

Now, as many worry that a correction is overdue in the still-booming market, there are some who believe investors holding rear-load shares, also called "B" shares, might be more likely to ride it out than those who paid up-front commissions.

"A" shares are the same portfolio of securities, but the commission is paid as a front-load -- a percentage taken out of the original investment. A $10,000 investment with a 5 percent commission would put only $9,500 to work for you.

With B shares, there is no up-front commission, so the full $10,000 is invested right away. But getting out can result in a fee -- often at 6 percent if you withdraw in the first year, 5 percent in the second, then 1 percentage point less in each subsequent year. This structure acts as an incentive for people to stay in the funds.

"Some of the data indicates that after the [1987] crash, B share retention was pretty good," said Jessica Bibliowicz, executive vice president in charge of Smith Barney Mutual Funds. "It seems that investors didn't want to pay a commission on top of losing money, and they stick around. It is a source of discipline."

Bibliowicz said B shares, which account for about 10 percent of all mutual fund money, have become the predominant form of investment for many portfolios primarily because "investors don't want to pay up-front commissions. They want to see all their money go to work."

Louis Harvey, president of Dalbar Inc., a Boston publisher that conducts mutual fund industry studies, offered another reason for B share popularity. He said a survey on why people with B shares stayed in bond funds longer than those who held A shares during the 1994 bond fund debacle found that "the broker, not the investor, was the driver. It is really up to the broker to advise an investor to stay in. I don't know that being in B shares and facing a commission was a deterrent to getting out. "The conclusion we came to," Harvey said, "was that ... those who sold A shares seemed to have more of a trading mentality."

The difference between A shares and B shares works this way: If you have $10,000 to invest and you buy a front-load fund with a 5 percent commission, you will invest only $9,500. If, in 1995, that fund grew 22 percent, and then another 19 percent last year, that $9,500 would have grown to $13,792, a $4,292 gain. But $10,000 in B shares, fully invested, would be worth $14,518, a gain of $4,518.

However, if you had decided to clear out at the end of 1996 because you felt the market was going south, you would have paid a 5 percent commission on the B shares, which would be $726, not the $500 charged on A shares. That is because the commission is based on the value of all assets, including investment gains.

How much would you end up with? Excluding the fund's expenses, you'd have $13,792, the same as with the front-load. But you'd probably have paid more in expenses, too, since the 12b-1 marketing fee for B shares is about a half-percentage point higher than for A shares.

There is a way around the rear-end commission for B shareholders who decide to get out of equities: Transfer the money into the same fund company's money market or bond funds and there is no commission, because it is an exchange, not a redemption. Keep in mind, however, that exchanges from fund to fund still involve a sale, which means you will owe tax on any profits. Consider it Uncle Sam's rear-end commission.