Key Takeaways
- Mutual funds pool money from many investors to buy a diversified portfolio of securities.
- NAV = (Total Assets - Liabilities) ÷ Shares Outstanding, calculated daily at 4:00 PM ET.
- Forward pricing means orders are executed at the NEXT calculated NAV, not the current price.
- Class A: Front-end load with breakpoints available for larger purchases.
- Class B: Back-end load (CDSC) that decreases over time; often converts to Class A.
- Class C: Level load with high ongoing 12b-1 fees; best for short-term.
- 12b-1 fees: Maximum 1% (0.75% distribution + 0.25% service); no-load funds max 0.25%.
- Breakpoints reduce sales charges for larger investments; failure to offer is a violation.
Mutual Funds
Mutual funds are investment companies that pool money from many investors to purchase a diversified portfolio of securities. They are regulated under the Investment Company Act of 1940.
How Mutual Funds Work
- Investors buy shares in the fund
- Fund manager invests the pooled money according to the fund's objectives
- Investors share proportionally in gains, losses, income, and expenses
- The fund charges fees for management and operations
Net Asset Value (NAV)
The Net Asset Value (NAV) is the per-share value of a mutual fund.
NAV Formula
NAV = (Total Assets - Total Liabilities) ÷ Shares Outstanding
| Component | Description |
|---|---|
| Total Assets | Market value of all securities held |
| Total Liabilities | Fund expenses and other obligations |
| Shares Outstanding | Total shares owned by investors |
NAV Calculation Timing
- Calculated once daily at 4:00 PM ET (market close)
- Uses closing prices of all securities held
- This is the price at which shares are bought and redeemed
Forward Pricing
Forward pricing means all orders are executed at the NEXT calculated NAV after the order is received.
| Order Received | NAV Used |
|---|---|
| Before 4:00 PM ET | That day's 4:00 PM NAV |
| After 4:00 PM ET | Next business day's 4:00 PM NAV |
Exam Tip: An order placed at 2:00 PM executes at that day's 4:00 PM NAV. An order placed at 5:00 PM executes at the NEXT day's 4:00 PM NAV.
Open-End vs. Closed-End Funds
| Feature | Open-End Funds | Closed-End Funds |
|---|---|---|
| Share Issuance | Unlimited, created on demand | Fixed number at IPO |
| Pricing | At NAV | Market price (can differ from NAV) |
| Redemption | From fund company at NAV | Sell on exchange |
| Where Traded | Through fund company | On stock exchanges |
| Premium/Discount | Never - always at NAV | Can trade at premium or discount to NAV |
| Leverage | Generally prohibited | May use leverage |
Share Classes
Mutual funds offer different share classes with varying fee structures:
Class A Shares
| Feature | Details |
|---|---|
| Sales Charge | Front-end load (paid at purchase) |
| Typical Load | 4.50% - 5.75% |
| 12b-1 Fee | Low (0.25% or less) |
| Best For | Long-term investors, large investments |
| Key Benefit | Breakpoints available for volume discounts |
Class B Shares
| Feature | Details |
|---|---|
| Sales Charge | Back-end load (CDSC - Contingent Deferred Sales Charge) |
| CDSC Structure | Decreases over time (typically 5-7 years) |
| 12b-1 Fee | High (up to 1%) |
| Conversion | Usually converts to Class A after 7-8 years |
| Best For | Medium-term investors who don't want front-end load |
Class C Shares
| Feature | Details |
|---|---|
| Sales Charge | Level load (small CDSC, typically 1 year) |
| 12b-1 Fee | High (up to 1%) annually |
| Conversion | Does NOT convert to Class A |
| Best For | Short-term investors (under 3-4 years) |
Share Class Comparison
| Factor | Class A | Class B | Class C |
|---|---|---|---|
| Front-end Load | Yes (4-5.75%) | No | No |
| Back-end Load | No | Yes (declines) | Small (1 year) |
| 12b-1 Fee | Low (0.25%) | High (1%) | High (1%) |
| Breakpoints | Yes | No | No |
| Best Holding Period | Long-term (5+ years) | Medium-term | Short-term (1-3 years) |
Exam Tip: Class A is best for LONG-TERM investors with LARGE investments (to get breakpoints). Class C is best for SHORT-TERM investors due to high ongoing fees.
Mutual Fund Fees
Sales Loads
| Fee Type | When Paid | Maximum |
|---|---|---|
| Front-End Load | At purchase | 8.5% (reduced with 12b-1 fees) |
| Back-End Load (CDSC) | At redemption | Varies, decreases over time |
12b-1 Fees
Rule 12b-1 allows funds to use fund assets for distribution and marketing expenses.
| Component | Maximum | Purpose |
|---|---|---|
| Distribution Fee | 0.75% | Marketing, advertising, broker compensation |
| Service Fee | 0.25% | Ongoing shareholder services |
| Total Maximum | 1.00% | Combined annual fee |
"No-Load" Fund Rules
A fund can only call itself "no-load" if:
- No front-end sales charge
- No back-end sales charge
- 12b-1 fees do NOT exceed 0.25%
Expense Ratio
The expense ratio is the total annual operating expenses as a percentage of average net assets.
| Expense Type | Included in Expense Ratio |
|---|---|
| Management Fee | Yes |
| 12b-1 Fee | Yes |
| Administrative Costs | Yes |
| Sales Loads | No |
| Transaction Costs | No |
Breakpoints
Breakpoints are volume discounts that reduce the front-end sales charge on Class A shares for larger investments.
Typical Breakpoint Schedule
| Investment Amount | Sales Charge |
|---|---|
| Under $25,000 | 5.75% |
| $25,000 - $49,999 | 5.00% |
| $50,000 - $99,999 | 4.50% |
| $100,000 - $249,999 | 3.50% |
| $250,000 - $499,999 | 2.50% |
| $500,000 - $999,999 | 2.00% |
| $1,000,000+ | 0.00% (NAV) |
Ways to Qualify for Breakpoints
| Method | Description |
|---|---|
| Rights of Accumulation (ROA) | Combine existing holdings with new purchase |
| Letter of Intent (LOI) | Commit to invest specified amount within 13 months |
| Household Accounts | Combine family member accounts |
| Same Fund Family | Combine investments across funds in same family |
Breakpoint Violations
Breakpoint selling is a violation when representatives:
- Fail to inform investors of available breakpoints
- Recommend purchases just below breakpoint thresholds
- Split purchases to avoid breakpoints
Exam Tip: FINRA requires disclosure of breakpoints. Selling shares in an amount just below a breakpoint threshold is a VIOLATION.
An investor places an order to buy mutual fund shares at 2:00 PM ET. At what price will the order be executed?
Which mutual fund share class is MOST suitable for an investor planning to invest $100,000 for 15 years?
What is the maximum 12b-1 fee a mutual fund can charge?
An investor wants to invest $48,000 in a mutual fund where the $50,000 breakpoint reduces the sales charge from 5% to 4%. A representative should:
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