Wednesday, December 12, 2018

Checklist for the DSC mutual fund investor

Thanks to D. McFadden 

For mutual fund investors, deferred sales charges (also known as “back-end fees”) can cause a lot of headaches when investors come to realize that their investments are essentially locked-in by deferred sales charge (DSC). The DSC is a fee that gets charged to a client (5-6% in year 1, declining to 0% in years 6-7) if they sell a mutual fund without transferring it to another mutual fund from the same company. There is no penalty fee if you switch funds within the same fund family but the dealer may charge a switch fee varying between 0-2%.

Investor advocates have warned investors for years about the DSC sold mutual fund. Securities regulators are proposing to ban them outright. If your fund salesperson attempts to sell you a DSC fund we suggest you ask Questions like:

1. Why are the MER’s of DSC funds identical to front load funds? Answer should be: The MER’s are identical because the fund companies have decided not to create a separate DSC series; this means that other fund investors are unknowingly subsidizing DSC unitholders.
2. What happens if I need access to cash during the redemption period due to a family or other emergency? Answer should be: A penalty must be paid per redemption schedule. No exceptions. 
3. Does the redemption penalty apply to original cost or current price of fund units? Answer should be: It varies by firm. Best to check with the firm. 

4. What happens if I take distributions in cash? Answer should be: If distributions are paid in cash they go toward the 10% of units that can be redeemed each year without attracting a redemption charge. 
5. Does the penalty still apply if I die? Answer should be: The penalty must be paid by the estate if the fund is redeemed. 
6. Can I redeem some units for free? Answer should be: Yes, 10% are free redemption units each year but privilege is not cumulative. Use it or lose it. 

7. Do I have to reinvest distributions? Answer should be: No, reinvestment is at option of unitholder.
8. What happens to my DSC units after the redemption period has expired? Answer should be: They remain as DSC units but with no redemption schedule ( at least one firm auto converts to Front load with lower MER). 
9. What commissions do you receive on this sale? Answer should be: The dealer and salesperson share a 5% upfront payment+ trailer commissions (typically 0.50% p.a.) for as long as you own the fund. 

10. Is there a cost to switch funds? How much? Answer should be: Yes. Cost can be up to 2%. Switch fees can be negotiated.
11. Is the redemption penalty tax deductible? Answer should be: Yes, in open account as it reduces returns; No in registered accounts where capital losses cannot offset gains.
12. Does it make sense to buy a money market fund on a DSC basis? Answer should be : No, since a money market fund is a temporary parking spot for cash, liquidity is key. 

13. What if the fund is merged with another fund I don’t like? Answer should be: A redemption from the merged fund will still involve an early redemption penalty fee. 
14. Can the MER be increased during the hold period? Answer should be: Yes, it could happen .
15. Why are regulators proposing to ban the DSC? Answer should be: There is a massive mis-alignment of investor-representative interests. 

16. Are reinvested distributions subject to a new redemption schedule? Answer should be: No . 
17. Do you sell other lower cost products? Answer should be: YES – Index funds, ETF’s among others. 
18. Are there other versions of the fund with shorter hold periods? Answer should be: Yes, no- load, front load (typically 0%) with no constraint on holding period and low-load funds are available with shorter redemption periods. Check with your fund salesperson. 

NOTE: In a number of well documented cases , unethical advisors will recommend redeeming a mutual fund as soon as the redemption schedule expires and buy a new fund, starting the dreaded redemption schedule all over again. A lack of liquidity is exactly the opposite of what investors need.

If after you receive honest answers, and you still want to buy a DSC fund, we wish you the very best of luck. DSC sold funds have been abused by salespersons. For example, when the redemption period expires, the salesperson will recommend selling the DSC fund and purchasing a new fund, thereby starting the redemption schedule all over again. In some cases, DSC funds have also been sold to clients with time horizons less than the redemption schedule. DSC investors, especially seniors, need to be wary of numerous shenanigans. Professional advisors do not recommend DSC series funds as they are not in your best interests. Be ALERT.

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