by Archie M. Richards, Jr., CFP^®
November 19, 2001

A fellow I'll call Dick, from Natick , Massachusetts , writes, "My broker seems competent, and I like him personally. He wants me to buy mutual fund C shares. He says he gets paid up front, but not out of my money. He says if I retain the fund for a year, I am charged nothing except expenses." Dick continues, "A shares worry me. The broker might buy and sell them to earn extra commissions. What do you think?"

You're aware, Dick, that most mutual funds sold by brokers offer Class A shares and Class C shares. These are the same except for how the broker gets paid.

With A shares, the fund pays a 4 or 5-percent commission and charges the full amount against your shares up front, one time.

With C shares, the fund pays the broker about 3 percent up front. It gets refunded by extra charges against your account every day, totaling 1 percent a year and continuing forever.

The broker misleads you when he says his C-shares commission is not paid out of your money. You certainly do pay the commission. You continue paying it indefinitely.

All mutual funds have expenses. But C shares charge extra expenses each year to refund the mutual fund for the brokerage commissions previously paid. It's deceitful for the broker to imply that the extra charges aren't commissions just because they're not called commissions.

The broker would have difficulty persuading you every few years to sell and buy the A shares of various mutual funds, earning large commissions each time.

But your broker might say, "Why don't we buy the C shares of this fund now. In a couple of years, if conditions have changed and the fund no longer seems appropriate, we can sell it. Your cost will be less than you would have paid for A shares."

Sounds reasonable, but it isn't. The premise that the broker can beat the market by knowing what's best to buy now and what will be best to buy in a couple of years is nonsense. The broker has no such knowledge. Neither do I, and neither do Wall Street hot shots. Long term, hardly anyone consistently beats the market by selling and buying.

But you buy the C shares, and a few years later, the broker says, "Let's sell that fund and buy the C shares of this fund over here." Bingo! He earns another commission. Even though you trade from one mutual fund to another, as long as you remain in C shares, you continue paying the extra 1-percent per year indefinitely. Selling and buying every few years enables the broker to make more than he would have made from a one-time purchase of A shares.

Why not just buy the entire market without a broker? Call 1-800-662-7447 to acquire the Vanguard Total Stock Market Index Fund. This tracks the broadest index of U.S. stocks and invests in about 3,000 of them. Operating costs are a trifling 0.2 percent, and you pay no commissions. Just buy and hold.

The broker wants you to buy a fund whose operating costs are probably much higher than 0.2 percent per year (the average is 1.2 percent). The C shares would also cost you an extra 1 percent. If the hot shots can't beat the market with low costs, do you really think you can beat it with extra costs of 2 percent a year?

Your broker seems competent, all right. It takes skill and a silver tongue to make things appear opposite to the truth.

If you hold an appreciated stock and want to make a charitable gift, do not sell the stock and give the proceeds to the charity. Instead, avoid paying tax on the profit. Give the stock itself to the charity. The charity sells it and incurs no tax. You may take a charitable deduction for the stock's full value.

If you hold stock at a loss and want to make a charitable gift, do the opposite: Sell the stock yourself and take a capital loss deduction. Give the proceeds to charity and take the charitable deduction too.