Further , with a DSC sale (advisor getting his/her upfront 5% and trailer of 0.5%) they then move 10% each year to FEL to get the higher trailer commission of 1%....it is really quite the racket enabled by the existing compensation structure.
As noted , the prevailing standard investment industry justification for DSC 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 retail investors do hurt themselves by jumping in and out of the market too much.The problem is that there is little definitive evidence that the DSC actually accomplishes this behavioural change . Additionally, if you're not getting the level of return you need this just traps you to stay with the same fund company. Investors might be interested in “buying and holding” but with a different fund; the DSC fee effectively prevents this.
In any event, flexibility matters more. Today's market swings are unprecedented and some investors are discovering that they have taken on too much risk. It's unacceptable to have to pay charges of up to 5.5% simply to adjust a portfolio to make it more suitable .And for retirees ,the need for more liquidity as unexpected expenses, particularly health-related and personal service expenses, rise , makes flexibility a key feature of portfolio design.
The real cost of buying DSC funds is often greater than is anticipated at time of purchase. In practice, what frequently happens is that the DSC either gets triggered by an early sale, or an opportunity is lost when the investor hangs on to a expensive/poorly performing fund in order to avoid triggering the DSC penalty fee.Incredibly , some money market funds are sold on a DSC basis which makes no sense since the purpose of holding a money market fund is liquidity.Such funds do pay trailers which may explain why you are sold them.
When investors are sold deferred sales charge mutual funds, instead of front-end funds, their main motivation is to save on fees. In fact, however, investors who hold these funds pay more, not less, in fees. An investor who buys a mutual fund on the DSC sales charge method pays no transaction fee at time of purchase. And if the fund is held for up to seven years the early redemption fee can be totally avoided. There is a significant cost, however, if the fund is redeemed before the end of the DSC schedule.
At the time of purchase, this waiting period never seems to be a problem. The investor is optimistic about the fund’s potential, or he/she wouldn’t let himself be sold it, and at this point he cannot imagine any reason to sell it before the DSC fee expires. Paying no fee sounds more attractive than paying even a relatively low 1% or 2% up-front fee ( actually 0% is most common today). In this case, the certain cost of 1% or 2% seems greater than the possibility of having to pay 5% or 6% in the unlikely event that the fund is sold before the DSC period expires. The thinking is that the DSC fee doesn’t matter because it will never be applied. Fund salespersons can exploit this thinking to their advantage.
This thinking frequently turns out to be wrong, however, because many investors do sell before the DSC fee schedule expires.The average investor hold period is 6-7 yeas, meaning that about 50% of funds are sold before DSC expiry. Further, very few mutual funds are themselves more than 7 years old ( due to mergers and closings) . The reality is that new and better products are always becoming available, mutual fund managers leave the fund they were managing, fees are increased, fund mandates change, the funds gets merged with another fund and sometimes fund managers go into a deep slump. For these reasons, investors routinely make a decision to sell the fund before the end of the DSC schedule. The fee is usually about 5.5 %, if redeemed in the first year, 5% if redeemed in the second, and so on. The fee for early redemption can be based on the purchase price or the market value at the time the fund is sold. This will be defined in the Prospectus
From the financial advisor’s point of view, selling on a DSC basis is initially more attractive than charging a front-end fee. With a DSC purchase, the dealer/financial advisor makes a commission of about 5%, which obviously is more attractive than the 0%,1% or 2% they would earn on a front-end sale. The bottom-line reason for the DSC fee is that the advisor gets paid by the fund company as soon as you have been sold the fund. If you don’t keep the fund, the mutual fund company needs to get its money back. They do so through the DSC early redemption penalty fee that you pay.The original advisor could be long gone either via retirement ,hopping over to another dealer or selling more lucrative insurance products .
Trailer commission paid to the dealer/ advisor are generally higher on the “front end” version of a mutual fund. Typically, the trailer commission on a front end fund is 1% per annum , while the trailer commission on a DSC fund is 0.5% per annum. Except for a few firms like Fidelity, the management expense ratio (MER) is generally the same for both the front end and DSC versions. Over the long term, therefore, the representative actually earns more by selling front end load funds.That is unless he/she redeems the fund at the end of the redemption period and sells you a new DSC fund, starting the nasty cycle all over again, a process called churning.
In some cases, the mutual fund owner effectively becomes a prisoner to the DSC fee. Often, to avoid triggering the DSC redemption fee, the opportunity to purchase improved or lower cost investments will be lost. Too many people feel they have no choice but to hang in for a few more years until the DSC fee expires – and to keep hoping that the markets would improve.If the investor dies or a major financial emergency occurs, the penalty will still have to be paid . There is definitely a benefit for liquidity.
Bottom line: Each year Canadians incur tens of millions of dollars in early redemption penalties or hold on to losers. We find it hard to see any benefit of allowing yourself to be sold a DSC mutual fund.