What's the difference between Class A, B and C mutual-fund shares?

QUESTION: I see Class A, Class B and Class C mutual-fund shares. What is the difference?

— M.E. Cruse


ANSWER: At first glance, the alphabet soup you're referring to can be confusing. But a few general guidelines will help you decipher what all those letters mean.

For starters, bear in mind that most lettered share classes identify load funds — funds that levy a sales charge, or load. The fund company charges this fee to compensate the commission-based broker or financial adviser who sells you the fund. You can avoid the whole alphabet issue by opting to buy no-load funds, either on your own or through an intermediary who charges a flat fee for his or her services. At SmartMoney.com, we have always recommended sticking with no-loads, on the theory that, however great or small your returns, paying a fee will most certainly diminish them. (For more on our reasoning click here.)

Sometimes a load fund makes sense, however — perhaps because a portfolio's performance is sufficiently outstanding to outweigh the load or perhaps because you want the advice the commission-based broker offers. So if you do choose to go that route, you'll quickly find yourself in a sea of letters. Each one identifies a share class and they are distinguished by a specific kind of load. There is no standardized system for labeling share classes — it's up to each fund firm — but a sort of de facto standard has emerged.

Before we spell out what each letter means, be aware that no matter what share class you choose, your fund purchase most likely will be subject to a so-called 12b-1 fee intended to cover annual marketing and distribution expenses. (Even no-load funds can levy a 12b-1 fee, as long as it doesn't exceed 0.25%.) The 12b-1 fee and other fund operating expenses comprise the expense ratio that is deducted from your investment each year.

Now for those share classes:

Most often, Class A shares carry a front-end load ranging from 1% to 5.75%, although the maximum permitted by the Securities and Exchange Commission, or SEC, is 8.5%. A front-end load is deducted from your original investment when you buy your shares — so you end up actually investing less than the amount you pay. But Class A shares usually bear a relatively low annual 12b-1 fee.

Class B shares generally carry a back-end load, also referred to as a "contingent deferred sales charge," or CDSC. This fee — often 4% or 5% — is applied when you redeem your shares. The good news is that back-end loads usually decline over time, often disappearing altogether after six or seven years. The bad news is that the 12b-1 fee is relatively high. In some cases, B shares convert to A-share status — and the lower expense ratio that comes with it. By that time, though, you will have paid the high 12b-1 fee for as long as seven years.

Finally, Class C shares increasingly carry what's known as a "level load" — a 1% or 2% back-end load coupled with a 1% 12b-1 fee — the maximum permissible. Alternatively, Class C may signify a 1% 12b-1 fee alone.

Investors who lean toward Class A shares generally like getting the load out of the way early so they can benefit from a lower expense ratio. Others investors prefer B and C class shares because if they stay in a fund for several years, they can exit with only a small back-end load. But they shouldn't overlook the high annual fees, warns Barbara Levin, executive director of the nonprofit Forum for Investor Advice. "Be aware that if you're buying a B- or C-share class of fund, you will be paying every year out of assets."

Since these A, B and C definitions aren't the same at every fund company, you should check the fee table in a fund's prospectus for precise information. Chances are, you'll find still more letter-designated share classes, ranging from D to Z. Those may identify other variations of the back-end load or perhaps point to an institutional or pension-fund share class.

Above all, remember that your broker is being compensated for selling you these share classes, and you should get the information you need in return. San Francisco-based financial planner Norman Boone says investors "shouldn't be afraid to ask what costs are involved" in the purchase of mutual funds. He recommends that investors query advisers about sales charges, expense ratios and 12b-1 fees. And always follow up, he says, with the question, "How am I going to be informed about these costs now and over time?"

The Forum for Investor Advice offers a free guide, "Sorting It Out: Payment Options for Financial Advice," which is available through the organization's Web site. It tells investors to ask their advisers questions such as, "How are you compensated, and how do I benefit?" and "Can you give me concrete examples of the potential differences in payment methods over various periods?"

If you're taking the load road, the most important question to ask yourself is whether you prefer upfront sales charges or pay-as-you-go fees. Once you answer that, making fund choices becomes much simpler. Says the Forum's Levin: "We try not to confuse investors by trying to get into the alphabet too much."