A Deferred Sales Charge (DSC), commonly known as a back-end load, is a fee that investors pay when they sell certain types of assets. It is typically associated with mutual funds and is charged only upon the sale of shares. The DSC is designed to discourage short-term trading and to compensate financial institutions or brokers for their sales services.
Structure and Calculation of Deferred Sales Charge
Fee Schedule
The amount of the deferred sales charge usually decreases the longer the investor holds the investment. For example:
- First year: 5%
- Second year: 4%
- Third year: 3%
- Fourth year: 2%
- Fifth year: 1%
- Sixth year and beyond: 0%
Calculation Example
If an investor sells shares worth $10,000 in the second year, and the DSC rate is 4%, the fee would be:
Implications for Investors
Encouragement of Long-Term Investments
Since the DSC decreases over time, it incentivizes investors to hold their investments for a longer period, reducing frequent trading.
Impact on Returns
Investors need to account for the DSC when calculating their net returns, especially if they plan to sell the investment within the initial years when the charges are higher.
Examples and Applications
Mutual Funds
Deferred sales charges are most commonly associated with mutual funds that have a Class B share structure. These charges help mutual fund companies recover the costs of commission and distribution services.
Annuities
In some annuities, a similar fee structure may exist, where surrender charges are applied if the investor withdraws funds early.
Historical Context
The concept of deferred sales charges dates back to the development of mutual funds in the mid-20th century. It emerged as a method for financial advisors to be compensated without upfront fees, aligning their interests with those of long-term investors.
Comparison with Other Fees
Front-End Load
A front-end load is a fee paid at the time of investment purchase, in contrast to a DSC. It immediately reduces the amount of capital invested.
No-Load Funds
No-load funds do not charge any sales fees, either at purchase or sale, though they may have other fees, such as 12b-1 fees for marketing and distribution.
Related Terms
- Expense Ratio: The annual fee that funds charge their shareholders.
- 12b-1 Fee: A fee for marketing and distribution, which can be part of the overall expense ratio.
- Surrender Charge: A fee similar to DSC, found in insurance products like annuities.
Frequently Asked Questions
Q: How can I avoid paying a Deferred Sales Charge?
A: To avoid paying a DSC, investors can hold onto the investment until the charge period lapses, typically after several years.
Q: Are Deferred Sales Charges tax-deductible?
A: No, DSCs are not tax-deductible. They are treated as a cost of selling the investment.
Q: Do all mutual funds have Deferred Sales Charges?
A: No, only mutual funds with a specific share class (often Class B shares) impose DSCs. Others may charge front-end loads or be no-load funds.
Summary
A deferred sales charge, or back-end load, is a fee incurred when assets are sold after a certain period. It decreases over time, encouraging long-term investment. Primarily associated with mutual funds, DSCs help financial entities recover sales-related costs. Knowing when and how DSCs apply can help investors make informed decisions about their investments.
References
- Investopedia. “Deferred Sales Charge (DSC) Definition.” Investopedia
- Morningstar. “What Is a Deferred Sales Charge?” Morningstar
- U.S. Securities and Exchange Commission (SEC). “Mutual Fund Fees and Expenses.” SEC
