Can you explain the different mutual-fund share classes? And do load expenses even out over time?

QUESTION: I own some funds with a 5.75% front-end load and a 1.25% yearly management fee. Is the load deducted from my initial contribution, or is the load deducted only after sales by the fund manager? Do load and no-load fund expenses even out over time, or should investors stick with no-loads?

-- R. Diaz

ANSWER: Excellent questions. Far too many investors ignore fees. A 1.25% annual expense ratio doesn't sound like much -- that is, until you crunch the numbers.

Consider that if you invested $10,000 in a fund with a 1.25% expense ratio (which is actually lower than average) and you earned 7% annually, you'd pay roughly $8,500 in fees over 20 years. That's right: After two decades, your account would have been worth approximately $38,900 (including your original contribution), but thanks to that fee, you'd be walking away with just about $30,400.

Needless to say, fees are critically important when it comes to mutual fund investing -- and we firmly believe that you shouldn't hand over a penny more than is absolutely necessary. And a load -- in any form -- is one fee that's best avoided.

But if you must pay a load (which is a sales commission paid to a financial adviser for selling a fund family's products), then you need to understand your different payment options so you can at least minimize your hit. And that means you need to have a firm grasp on the tricky issue of share classes.

There are three common types of fee structures associated with load mutual funds: front-end, deferred and level loads. Class A shares, which carry front-end loads, deduct the fee from your initial contribution. What's left after that deduction is then invested in the fund. So to answer your first question: If you put $10,000 in a mutual fund with a 5.75% front-end load, a $575 sales commission (or load) will be taken upfront and the remaining $9,425 will be invested. In addition to a load that can range from 1% to 6%, Class A shares typically come with somewhat lower expense ratios (the percentage of mutual-fund assets deducted each year for management fees, operating costs, administrative fees and all other costs incurred by the fund) than other share classes, mainly because they have lower 12b-1 fees (these are marketing fees that are often passed along to shareholders). In addition, most fund families provide load "breakpoints" when you invest larger amounts of money (the more you invest, the lower your load), so high-net-worth investors stand to profit the most from A shares, according to Lucas Garland, a research analyst with mutual-fund tracking company Lipper.

Deferred loads, typical for Class B shares, are deducted when you sell your mutual-fund shares. These back-end fees range from 5% to 1%, typically decreasing by one percentage point for each year you've held the shares. So the longer you're invested in the fund, the smaller the fee. The catch here is that Class B shares typically come with a higher 12b-1 fee than Class A shares, which in turns inflates the fund's expense ratio. However, B shares typically convert into A shares after eight years, so the load disappears and the 12b-1 fee decreases. This share class makes sense for long-term and lower-net-worth investors who can't take advantage of the breakpoint structure of A shares.

Finally, mutual funds that have level loads, or Class C shares, carry no upfront sales commission, but charge a high 12b-1 fee (typically 1%) and thus come with a higher expense ratio each year, no matter how long you hold the fund. Moreover, in some cases you could be charged a small back-end fee if you sell within the first year, explains Emily Hall, a senior mutual-fund analyst with Morningstar. Morningstar analysts discourage investors from buying C shares at all, says Hall, since "they don't convert, and you end up paying that higher fee over the long haul." That said, you might consider level load shares if you have a short-term investment horizon, such as two or three years.

Now on to your second question: Does it ever make sense to pay a load? Generally speaking, we don't think so. Not only do no-load funds skip the sales commission -- they tend to have lower expense ratios, too. And lower expenses means you get to keep more of your profit. "When we look at expense ratios, we've found that over time, funds that are cheaper tend to have a performance advantage over funds that are more expensive," says Morningstar's Hall.

Of course, there are always exceptions to the rule, and some load funds offer such superior returns when compared with their no-load counterparts that paying a load could be justified.