Tuesday, November 25, 2014

"A" Shares May Have Highest Redemptions in 21 Years

Morningstar estimates that "A" shares, the most common mutual fund share class among retail investors, may have its largest redemption year in history in 2014. Over $122 billion dollars have been removed from "A" shares so far this year, and the number is still growing.

Why the redemptions? The short answer is that investors want better returns. Imagine that the S&P 500 returns 15% one year.  An "A" class S&P 500 Index fund with a 4 1/2% load plus 1 1/2% internal management fee may return only 9% (15% return minus 4 1/2%, minus 1 1/2%). On a $100,000 account, that 6% difference means $6000 in underperformance to the investor!

Where does that $6000 go? Why, it goes to the commission stock broker's pocket, and to the bottom line of the brokerage firm he or she works for!

Where is all the money going that is leaving "A" shares? Well, a large part of it is going to lower cost funds and ETFs that do the same thing as the higher cost funds. Rather than using an S&P 500 "A" class fund that keeps 6% of the investor's money, many investors are using ETFs like the Vanguard S&P 500 ETF, which has only 0.05% in fees. In other words, Vanguard keeps $50 of your money for expenses versus the "A" class fund keeping $6000 of your money for expenses. In the above example, your net return would be 14.95% rather than the "A" class return of 9%.

Other low cost funds and ETFs are offered by Dimensional Funds, iShares, SPDR, etc.

Keep more of your money. Work with a fee-only fiduciary, and use the very least expensive instruments you can to access the areas of the market you wish to access.