Question

Fund A has a front-end load of 4.5% (of the year-beginning amount). Meanwhile, Fund B has a backend load of 6% which decreases by 1% per year. That is, the backend load will be at 5% if the investor sells the fund at the end of year 2, 4% at the end of year 3, and so on, until it becomes zero. In addition, Fund B charges additional 12b-1 fee of 0.5% per year at each year end. Assume Fund A’s net return of the expense ratio per year is 10% and B’s is 11%. Both fund earn the same return. Which fund would an investor choose if he plans to invest for three years (i.e., buy and hold for three years)? Which fund would he choose if he plans to invest for five years? Ten years? Assume there is no income or capital distribution during the holding period and the investor’s choice is based on return only.

Answer 1

Best fund to invest for 3 years is as follows

a.) Fund A Front - end load (charge paid at the time of purchase of a fund) is 4.5%. Whereas for Fund B - backend load fee (paid at the time of redumption) at the end of 3 years will be 4%

b.) Additional fees of 0.5% per year at the end of the year.

c.) Expense ratio for fund B is 11% as compared to 10% for fund A. (how much the fund charges in terms of percentage annually to manage your investment portfolio)

Considering the above details Fund B is a costlier fund (4% charge at redeem + 0.5% per year additional fees+ 11% per year for management) when compared to Fund A (4.5% charge at the time of purchase) even though they have the same returns. Hence invest in A.

Best fund to invest for 5 years is as follows

All the conditions are same except

a.) Whereas for Fund B - backend load fee (paid at the time of redumption) at the end of 5 years will be 2%. Still Fund A is a better fund to invest in as Fund B will be charging higher cululatively.