Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Contingent Deferred Sales Charge

What it is:

Also called a back-end load, a contingent deferred sales charge is a fee paid to sell a specific investment. It is expressed as a percentage of the amount invested, and may also be called an exit fee or a redemption charge. Mutual funds with contingent deferred sales charges are often referred to as B Shares.

How it works (Example):

Contingent deferred sales charges are commonly assessed on the beginning value of the investment, although some companies calculate the fee on the ending value if the share price is lower than the original purchase price.

Let's assume you make a $10,000 investment in the Company XYZ mutual fund, which has a 4% back-end load. The presence of the contingent deferred sales charges means that the investor must pay a $400 fee upon the sale of the investment ($10,000 x .04). Ideally, the earnings from the investment should more than make up for the contingent deferred sales charges. In this example, the fund must therefore return 14% in one year to reach $11,000 in value after the fee, but the no-load fund must only return 10% to do so.

Generally, contingent deferred sales charges are reduced for each year the investor holds the investment. If the investor holds the investment long enough, i.e. for the duration of the surrender period, many fund companies waive the back-end fee. For example, a contingent deferred sales charge might be 5% in the first year, 4% in the second year, and so forth until the fee is zero. Additionally, some fund companies automatically convert B shares to A shares after the surrender period.

Why it Matters:

Loads discourage investors from frequently trading their mutual fund shares, an activity that requires mutual funds to have considerable amounts of cash on hand rather than invested. Generally, however, a load is considered payment for the broker's expertise in selecting the right fund for the investor. Notably, there is considerable controversy about whether funds with contingent deferred sales charges perform better or worse than other types of funds.

Contingent deferred sales charges are most often associated with mutual funds, but annuities, partnership interests and life insurance investments may also have contingent deferred sales charges. Mutual funds must disclose contingent deferred sales charges and other fees in their prospectuses, and it is important to understand that contingent deferred sales charges are only one of several types of fees that may be charged. Thus, when comparing investments, investors should evaluate all fees associated with an investment, not just the size of the fee. Additionally, the nature of the investment, the investor's risk tolerance and the investor's time horizon should always be considered when evaluating any investment.

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