C shares and how they fit into my business

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(I feel the need to write this post before getting to the top 10 things you need to know about Class C shares because I think its important to be as transparent as possible, especially, when writing about a product class that I use in my business.)

In a previous post back in July, I mentioned that sometimes I use C share mutual funds to build client portfolios. C shares make up less than 2% of my business, with the overwhelming majority of my client portfolios using ETF’s.

But, from time to time, I do come across prospective clients that don’t want ETF’s, for whatever the reason. Sometimes a prospect is fee conscious or is just very comfortable with mutual funds (usually the 2 characteristics go together).

C share is best of breed

If I end up working with this type of client, then I believe a C share based portfolio is the best way to go. When it comes to load mutual funds, I believe the C share is in the best interest of clients, as well as, a fee based advisor like me.

The debate rages on

When it comes to mutual funds, there’s still much debate about which share class is better, the C or the A.

Under optimal conditions, Class A shares make the most sense. If a client plans to buy and hold the same mutual fund investment for 8 years +, then A shares are the most cost effective way to invest… hands down.

But in the real world, clients very rarely hold the same funds that long. Life, much like financial planning, is situational and dynamic. Things are always changing that force you to reexamine previous decisions. Life doesn’t take place in a lab.

The average mutual fund today is held for around 3 years and I believe clients need the flexibility that comes with a C share, as do financial advisors.

Please don’t confuse that last sentence with me advocating holding a mutual fund for 3 years or less, because that goes against everything I’ve written. But because life can throw anything at you, at any time, flexibility becomes an important arrow in your investment quiver.

The following is a short list of unforeseen changes that make having C shares the best (real life) alternative:

• re-balancing client portfolios means periodic buying and selling
• poor performance may justify moving out of a specific fund
• fund management shakeups may justify a fund change
• client emergencies may justify selling
• client/advisor alignment means no suspicion of churning to generate excess commissions (something which is more prevalent with A and B share funds.)
• there’s no conflict of interest if recommending a fund switch, for whatever the reason

I hate to say this but C shares sometimes save clients from themselves. Often, even when fully explained, clients don’t understand the restrictions associated with a B share. Whatever the reason, what matters is knowing you have the flexibility to be nimble and act quickly; and C shares give you that.

From a compensation standpoint

I think it’s important to note that I’m paid a 1% annuitized trail, (from the mutual fund company) that’s more or less the same as my fee based model.

I’m not interested in receiving upfront commissions (A share) and never sell B shares. I prefer C shares because it allows me to work closely with clients, stay motivated and remain fairly compensated for providing ongoing financial planning services.

In case you’re wondering… that 1% trail comes from ongoing (12b-1) fees that are charged against the assets of the fund. In plain English, the 1% trail, come right off the top of the fund’s performance, in the form of higher fees. In essence, if the fund were to return 11% on the year, the client would net 10%.

The moral of the story

When it comes to advisor recommended mutual funds you’re gonna get hit with fees (or charges) one way or the other. In my book, class C shares make the most sense.

Now you know what my favorite letter in the mutual fund alphabet soup is…

I’ll leave you with this

Please realize, if I sound overly negative, it’s only because I think investors have a better first option (ETF’s) and I tend to be passionate about it. A friend of mine read my last few posts and said to me, “you sound biased toward ETF’s.” I responded by saying, “I am.”

With that said, I bid you good night…

Still on deck: 10 things you need to know about Class C shares mutual funds…

Tags: Advisor Compensation, Class C Share Mutual Fund, Mutual Funds