After the global financial crisis took a chunk out of Roger Ryan's investments, his mutual fund companies took a turn.
Mr. Ryan invested $150,000 in three funds several years ago. He switched his investments into money market funds in the dark days of late 2008, and then cashed out altogether earlier this month. In selling his funds, he incurred $5,839.98 in redemption fees.
They call these deferred sales charges (DSCs) in the fund world and they're a factor in 21 per cent of funds sold last year, according to data from the analysis firm Investor Economics.
The DSC share of the fund marketplace has fallen sharply in recent years. Now, let's finish the job and eliminate DSCs altogether. DSC funds were an irritant in years gone by, but in today's fast-changing financial world they're potential wealth killers that should be avoided.
Mr. Ryan is a 59-year-old freelance translator in Montreal who in late 2005 invested a small part of his savings in three mutual funds suggested by his adviser - Manulife China Opportunities, Fidelity Global Real Estate and a fund from the Franklin Templeton family that is now called Quotential Balanced Growth Portfolio.
Each of the funds was purchased in a DSC version, which means Mr. Ryan paid no commissions to buy them but put himself in a position of having to pay a redemption fee if he sold his holdings in the first seven or so years after buying them.
Investor Education: Mutual funds
Mr. Ryan's experience highlights the first big problem with DSC funds - investors too often don't have a sense of what they're getting into.
"I definitely didn't understand," Mr. Ryan said. "I certainly didn't expect that four years down the road, a deferred sales charge of that size would still apply."
Deferred sales charges work on a declining scale that typically starts at 5.5 per cent in the first year (sometimes that applies to the amount you invested, and sometimes to the current value of your holdings) and declines to 1.5 to 2 per cent in the seventh year before disappearing altogether.
DSC funds evolved as an alternative to selling funds with a big front load, the industry term for an upfront sales commission. In offering the DSC option, an adviser could say to clients that they would be able to put all their money to work - no commissions or fees to pay - and avoid redemption charges if they did the sensible thing and held for the long term.
Mr. Ryan doesn't recall his adviser asking about whether he was investing for the short or long term, which highlights a second problem with DSC funds. If a lot of thought hasn't gone into picking your funds, deferred sales charges can really compound your problems if you need to make changes in your portfolio.
The Quotential Balanced Growth Portfolio is a conservative type of investment, but the Manulife China and Fidelity real estate funds were significantly higher risk. You shouldn't invest in them if you plan to invest for only a short time, if you need your money and can't afford to lose any of it, or if you have a low tolerance for volatility.
"I have to say that I don't recall my adviser asking those kind of questions," Mr. Ryan said.
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