Reducing the Sales Charge of Open-End Funds

tamer hamed 2:41:00 AM
Although A-shares charge a front-end load, investors can reduce that sales charge by employing various methods laid out in the prospectus.

Breakpoints
Breakpoints are quantity discounts. If the investor invests $1,000, he pays a higher
sales charge than if he invests $100,000. For mutual funds, investors are rewarded
with breakpoints. Let's say the L&H Fund had the following sales charge schedule:


That means an investor who buys $100,000 worth of the fund will pay a much lower sales charge than an investor who invests $20,000. In other words, less of her money will be deducted from her check when she invests. A break-point means at this point the fund will give the shareholder this break. A lower sales charge means an investor's money ends up buying more shares. For mutual funds, we don't pick the number of shares we want; we send in a certain amount of money and see how many shares our money buys us. With a lower sales charge, our money will buy more shares. Fractional shares are common. For example, $1,000 would buy 12.5 shares if the POP were $80.

Breakpoints are available to individuals, husbands & wives, parents & minor child in a custodial account, corporations, partnerships, etc. So, if the mom puts in $30,000 and also puts in $20,000 for her minor child's UGMA account, that's a $50,000 investment in terms of achieving a break-point. The child cannot be an adult; he must be a minor. Corporations and other businesses qualify for breakpoints. About the only people who don't qualify for breakpoints are investment clubs.

A securities agent can never encourage an investor to invest a lower amount of money to keep him from obtaining a lower sales charge offered at the next break-point. That's called break-point selling and is a violation of FINRA rules. Like¬wise, if an agent fails to point out to an investor that a few more dollars invested would qualify for a break-point, that's just as bad as actively encouraging him to stay below the next break-point.

If a front-end-loaded fund has a break-point at $50,000, the registered representative should inform any investor who has even close to $50,000 to invest about that break¬point. If the customer in the question has, say, $46,000, the agent must inform him about the break-point available for just $4,000 more.

Letter of Intent (LOT)
What if the investor didn't have the $100,000 needed to qualify for that break-point? He could write a letter of intent explaining to the mutual fund his intention to invest $100,000 in the fund over the next 13 months. Now, as he sends in new money, say, $5,000 at a time, the fund applies the lower 4% sales charge, as if he'd already invested the full amount. The lower sales charge means he ends up buying more shares, right?

So, guess what the fund does? It holds those extra shares in a safe place, just in case he fails to invest that $100,000 he intended to. If he doesn't live up to his letter of intent, no big deal. He just doesn't get those extra shares. In other words, the higher sales charge applies to the money invested.

Also, that letter of intent could be backdated up to 90 calendar days to cover a previous purchase. If an investor bought $3,000 of the L&H fund on March 10, he might decide in early June that he should write a letter of intent to invest $50,000 over 13 months. He could backdate the letter to March 10 to include the previous investment and would then have 13 months from that date to invest the remaining $47,000.

Rights of Accumulation
If an investor's shares appreciate up to a break-point, the investor will receive a lower sales charge on additional purchases. In other words, when an investor is trying to reach a break-point, new money and account accumulation are counted the same way. So, if an investor's shares have appreciated to, say, $42,000 and the investor wanted to invest another $9,000, the entire purchase would qualify for the break-point that starts at $50,000. In other words, the $42,000 of value plus an additional $9,000 would take the investor past the $50,000 needed to qualify for the 5% sales charge.

This is known as rights of accumulation. It has nothing to do with a letter of intent. If you write a letter of intent to invest $100,000, you'll need to invest $100,000 of new dollars into the fund to get the break-point you're intending to get.

Rights of accumulation means you could save money on future purchases, based on the value of your account.

Combination Privilege
Most funds are part of a "family" of funds. Many of these fund families let investors combine a purchase in their Income Fund with, say, their Index or Growth Fund to figure a break-point. They call this a combination privilege. So, if the individual invests $20,000 in the Income Fund and $30,000 in the Growth Fund, that's considered a $50,000 investment in the family of funds, and that's the number they'd use to figure the break-point.

Conversion/Exchange Privilege
The fund might also offer a conversion/exchange privilege. This privilege allows investors to sell shares of, say, the L & H Growth Fund to buy shares of the L & H Income Fund at the NAV, rather than the higher POP. However, while buying the new shares on a net asset value basis is nice for the investor, the IRS considers the sale a taxable event. That means a capital gain or loss is realized on the date of the sale.

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