On the surface, share class exchanges appear confusing: a same-day buy and sell of the same mutual fund with a Schwab transaction fee attached.
Upon seeing an exchange in your account statement, an understandable reaction would be … let me get this straight, I’m paying $15 or $25 for a roundtrip into the same fund? What are you guys doing?
Exchanges demonstrate how much value is in the details. Ensuring that our clients own the correct share class can help save and build a remarkable amount of lifetime wealth.
Most mutual funds have multiple share classes, each with their own five-letter symbol. The only difference between share classes is fees – recurring fees (expense ratio) and transaction costs. The various share classes own the exact same investments. The difference is how much of the investment return the fund shares with you.
BEW uses two different types of share classes (1) institutional and (2) no-transaction fee (NTF).
Institutional shares have the lowest expense ratio. They are generally unavailable to retail investors due to large minimum purchase constraints. Our clients can purchase institutional shares due to BEW’s size. Schwab charges a transaction fee to trade institutional shares. We recently renegotiated to drop the transaction fee to $15 or $25, depending on the trade size.
The NTF share class incurs no transaction fee to trade but carries a higher expense ratio (as much as 0.38% more than institutional).
BEW does not receive any revenue from these fees. We have the opposite incentive – to grind fees down and preserve our clients’ capital.
Which Share Class to Purchase?
Whether to buy institutional or NTF shares depends on which we expect to cost less for the long-term investor. Generally, we will purchase institutional shares if the savings over one year exceed the transaction cost.
For example, DoubleLine Total Return Fund’s institutional share class (Class I) has a 0.47% expense ratio. The Fund’s NTF share class (Class N) costs 0.72%. If we buy $50,000 of DoubleLine, then the $25 Schwab transaction fee will be less than the fee difference for one year ($50,000 x 0.25% = $125).
For smaller purchases, we use NTF shares because the higher recurring expenses will cost the client less over a year than the transaction cost. NTF shares also provide flexibility to make small trades without paying a fee.
Share Class Exchanges
Here’s where the same-day buy and sell enters. Often, over time a position in NTF shares will grow large enough that the client should own institutional shares. Or, a mutual fund will introduce a new institutional share class. In those situations, we analyze whether an investor would benefit by exchanging one share class for another.
To the investor, the exchange misleadingly appears as a buy and sell of the same fund. Yet, the investor’s ownership of the fund never lapses and no taxable event occurs. The fund’s cost basis remains the same.
The Amazing Power of 0.25%
Saving $125 on a $50,000 purchase hardly seems worth discussing. However, that only scratches the surface.
Let’s say you invested $1 million and we could lower your expenses by 0.25%. That saves $2,500 per year (not counting transaction costs). That’s real money, but again only scratches the surface.
Let’s track two investors, Henry and Isaac, who start with $1 million and own the exact same funds over 30 years. The only difference is Henry pays the 0.25% higher expense ratio and Isaac owns institutional shares. It’s tempting to multiple $2,500 x 30 years and come up with Isaac’s savings of $75,000.
That ignores the opportunity cost of lost growth. Every year of Isaac’s fee savings is invested. If Isaac earned 7.00% annualized for 30 years and Henry earned 6.75%, that 0.25% difference amounts to over half a million dollars! Compound interest: the 8th wonder of the world!
Control What You Can Control
The share class discussion highlights a major philosophy of BEW: control what you can control.
We cannot control the markets, interest rates, or politics. What we can control are investing nuts and bolts like share classes. Often overlooked for more exciting topics, portfolio construction basics can have a powerful effect.