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Mutual Fund Purchase Options Are Not All Equal

11/21/2014 04:13 EST | Updated 01/21/2015 05:59 EST

Take a look at your most recent investment statement. Do you see the acronym DSC on any of the pages? If you do, you'll want to keep reading.

I recently met with a couple who moved to British Columbia from Alberta. Their investment statements disclosed a variety of mutual funds and were littered with these three letters. They asserted that whenever they wanted to move from one investment to another, their advisor would 'rebate' the DSC charges, so there was no need to worry about them.

The offer to rebate fees was honoured by the former advisor. Every time they changed from one fund to another, he refunded the fees charged to the clients. What they didn't realize is that he was being paid a new, larger fee as money was reinvested into the new DSC fund and the clients' seven-year DSC time schedule reset back at zero.

When a mutual fund is purchased on a deferred sales charge (DSC) basis, the investment advisor receives a five-percent commission up-front from the mutual fund company, based on the value of the new investment. You on the other hand, have to leave your money in that investment or a related fund, for up to seven years. If you withdraw earlier, you are charged a fee designed to offset the initial commission paid to the advisor.

These DSC fees are in addition to ongoing management fees and management expense ratio (MER), part of which is also paid to the investment advisor.

The offer by this particular advisor was good enough until the clients decided to update their investment strategy. That's when they discovered that withdrawing their funds posed a huge problem. Not only were they subject to DSC fees, but also due to the regular changes that they had agreed to, they were subject to the highest fee schedule on most of their assets. If they had needed their money for personal reasons, they would have been penalized almost five-percent of the value of their entire portfolio to access their money.

Mutual Funds are a widely offered investment vehicle and the DSC purchase option unfortunately remains a preferred choice by a huge contingent of investment advisors, due to the generous initial compensation provided. As an investor, you may be interested to know that all mutual funds are available with a variety of purchase alternatives. Low-load is one avenue with which the mutual fund company pays a two-percent commission up-front to the advisor and carries a shorter withdrawal schedule for the investor. Alternatively, investors can pay a front-end fee ranging from zero to two-percent, to maintain the right to withdraw funds at any time without penalty.

Today, with the advent of popular investments that do not have entry or exit fees, such as Exchange Traded Funds (ETFs), many investment professionals do not charge front-end or DSC fees, opting instead to only collecting the active management fees. Moreover, mutual funds are also available for fee-based accounts where no trailers, front-end or DSC fees are incurred since the client's account is directly responsible for service costs.

If you find that you have purchased mutual funds with a DSC schedule, there are smart ways to extricate yourself from them. The next column will outline each of the necessary steps to strategically unwind these positions.

This information should not be construed as investment advice, nor can it take into account your own specific circumstances. The opinions formulated within this article are based on sources believed to be reliable; may not cover all aspects of the topic; and may not reflect the opinions of any organizations that I am affiliated with.