Question

Suppose an investor purchases shares in a mutual fund with a 3.5 percent front-end load and expects to hold the shares for 8 years. What is the annualized sales load incurred by the investor? What would the annual shareholder cost be if the expense ratio (including 12b-1 fees) was 2%? Explain what 12b-1 fees are and also describe in detail the differences explained din your book between open-end mutual funds,

Answer 1

The annualized sales load on a mutual fund with a 3.5% front-end load held for 8 years is 0.4375% per year. 12b-1 fees are part of the 2% expense ratio, which covers distribution and marketing costs. Over a period of 30 years, the investor who does not pay any administrative fees will have more money than one who does, due to fee savings and potentially higher earnings.

Step-by-step explanation:

When an investor purchases shares in a mutual fund with a front-end load, they pay a sales charge upfront which reduces the amount of their investment that actually goes into buying fund shares. In this scenario, with a 3.5 percent front-end load, the investor is looking to understand the annualized sales load. To calculate the annualized sales load, we take the initial sales load of 3.5% and spread it over the 8 years the investor plans to hold the investment. The idea is that this cost diminishes impact each year because it's a one-time fee.

To annualize the sales load, we divide the front-end load percentage by the number of years the shares will be held: 3.5% / 8 years = 0.4375% per year. However, it's important to note that this is a simplistic calculation that does not take the time value of money into account.

Regarding the annual shareholder cost, if the fund has an expense ratio of 2%, this includes management fees, administrative fees, and potentially 12b-1 fees. 12b-1 fees are annual fees charged by the fund to cover distribution and marketing expenses, which can include commissions to brokers and other salespersons. The total annual shareholder cost would thus be 2% of the fund's average net assets.

Example provided: Alex and Spenser each invest $5,000 in the same stock. Alex does not incur any administrative fees and earns an annual return of 5%, while Spenser, using a retirement fund, pays a 0.25% fee and earns 4.75% annually. Over 30 years, this difference in fees and returns accumulates, and to find out how much more Alex will have than Spenser, we need to calculate the future value of the investments for both individuals and then compare them.