Skip to main content
rob carrick

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

  • Feeling ripped off, investors? You're not alone
  • How do I choose mutual funds that are right for me?
  • Beware of shocking fund fees
  • When to sell a mutual fund
  • Mutual funds: A good place to start

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.

More on financial advisers:

  • Let's get the ethics clear here
  • What if advisers couldn't accept commissions from mutual fund companies?
  • Video: How your adviser is paid
  • Video: Is your financial adviser just pushing funds?
  • Take a closer look at your adviser, and be skeptical
  • Provide true value or advisers are 'toast'

The question of risk tolerance became relevant in the fall of 2008, when the stock market was posting the worst losses many investors had ever seen. Mr. Ryan asked his adviser to get him out of the three funds he had purchased (the China fund was up a lot, the other two were down), and he doesn't recall getting any pushback about needing to stay in for the long term.

Not that it would have mattered. "At that point," he recalled, "I'm pretty confident I would have just said it's time to get out."

Mr. Ryan was able to move into money market funds at no cost because DSC funds allow switches within the same family without triggering redemption fees. But when he decided to use his money market fund holdings to buy a condo recently, the redemption fees finally kicked in. Between them and market losses, his $150,000 investment was reduced to $135,108.13.

Deferred sales charges are stealth wealth killers that investors can ill afford in these uncertain times. That's a third reason to avoid DSC funds.

The standard investment industry justification for deferred sales charges is that they provide an incentive for investors to stay in their funds for the long term and not make self-destructive moves in and out of the market.

There's some validity to this because investors do hurt themselves by jumping in and out of the market too much. But flexibility matters more. Today's market swings are unprecedented and some investors are discovering that they - and their advisers - have taken on too much risk. It's unacceptable to have to pay charges of up to 5.5 per cent simply to adjust a portfolio to make it more livable.

Look to the commissions paid advisers who sell funds to understand why the deferred sales charge option persists. Fund companies pay advisers who sell DSC funds a 5-per-cent upfront sales commission that must be shared with their firm. The adviser then receives ongoing yearly compensation -called trailing commissions - of 0.15 to 0.5 per cent.

Ted Rechtshaffen's Adviser Secrets series:

  • Part 6: Do you want to protect your lender or your family?
  • Part 7: You can be too rich
  • Part 8: Your company pension plan: Demand a great deal

Advisers who sell funds with an upfront commission may charge 1 to 2 per cent, or nothing at all, and then collect higher trailing commissions of up to 1 per cent in most cases. DSC pays more in total compensation to advisers in the short term, it's a wash with front loads over the medium term and it trails front load over the long term.

The reason why advisers prefer DSC in some cases is that it works better from a business point of view, said Dan Richards, a consultant who works with advisers to help them build their businesses.

For one thing, new clients sometimes require a lot of upfront planning work. The upfront pop of a DSC commission helps pay for that, Mr. Richards said. DSC funds also address those increasingly common situations where advisers work with new clients who end up moving on in fairly short order.

Also, some advisers just like getting paid upfront, Mr. Richards acknowledged.

"It's the bird in the hand scenario," he said. "That's where advisers say, 'Yeah, frankly I probably do get paid more over time if I do the front end, but I'd rather have the money today.' "

Mr. Ryan's feelings about mutual funds suggest the industry itself might have something to gain by phasing out DSC funds. He said his experience has made him extremely reluctant to buy any more funds.

"I'm looking at ETFs [exchange-traded funds]in a whole different light now."

Buy Now, Pay Later

With deferred sales charge (DSC) mutual funds, you can buy without paying any upfront sales commissions. However, you're subject to redemption fees that typically start at 5.5 per cent and decline to zero over seven years. Here's how DSC funds work:


Your investment in the DSC version of the XYZ Cdn Equity Fund.

The lowdown: Always discuss alternatives with advisers who want you to buy DSC funds. Most funds have a front-load version (you may have to pay upfront commissions of up to 2 per cent, but there are no redemption fees) and some have a low-load version where the redemption fees disappear after three or so years.


Upfront sales commissions paid by you in the DSC version of this fund.

The lowdown: More and more advisers are selling front-load funds with the purchase commission waived. This is called zero load and you should ask about it.


Sales commission paid to your adviser by the fund company and shared with the adviser's firm.

The lowdown: Five per cent is a big chunk of change for a fund company to pay an adviser up front. In order to make the money back, a fund company needs you to stay in your fund for a while. Hence the redemption fees to hem you in.


Annual trailing commissions paid to your adviser by the fund company.

The lowdown: Trailing commissions are designed to compensate advisers for ongoing client service and they're paid by fund companies out of the haul of fees they charge their investors. An adviser who sold a fund with a front load would be making $100 here.


Penalty for selling your fund in the first year after you buy.

The lowdown: Leaving so soon? Guess your fund company will have to recoup that 5-per-cent commission it paid your adviser when you bought your fund.


Fees you'll pay if you switch to another fund in the same family. This may or may not be an option, depending on how consistent your fund company is across its product lineup.


The maximum amount you can withdraw from your fund without incurring a redemption fee in the first year after purchase. Most companies have this 10-per-cent per year provision. It's not usually cumulative, so use it or lose it.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe