Reduce the sting of the DSC

Taking the hit on mutual fund DSCs is usually worth it if you’ve decided to manage your own money using a discount brokerage.

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From the February/March 2014 issue of the magazine.

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In order to take advantage of the great mutual funds listed here, you may need to free up money trapped in old, underperforming funds. But first, you need to be aware of deferred sales charges (DSCs)—fees payable at the time you sell funds. If you’re working with a commission-based adviser, your mutual funds may carry one.

A typical DSC starts at 5% or 6% of the amount of your original investment during the first year you own the fund, then gradually declines by a percentage point each year until it’s at 0% after about six years. Some advisers argue this encourages investors to buy and hold mutual funds longer, but problematically DSCs may lock investors into funds they don’t want anymore. For example, if you invested $25,000 a year ago and decided the mutual fund wasn’t performing well, triggering a 5% DSC would cost you a sizable $1,250.

Taking the hit on this type of sales charge is usually worth it if you’ve decided to manage your own money using a discount brokerage—it clears the slate and lets you construct a low-cost portfolio. However, check the cost of the DSC with the fund company first. If you feel the fee is excessive, you may be able to switch the funds “in kind,” meaning you transfer them to your new account without selling them, thereby avoiding triggering the DSC. Then you can divest gradually to keep the DSC at a minimum. Most fund companies allow you to sell 10% of the fund annually without charge.

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