What are DSC and FEL fees?
There are generally two sales options a non-fee based advisor has, front-end load (FEL) and DSC.
With the FEL, the advisor can charge you 0% to 5% up front, which comes directly from your investment. So, if you invest $100,000 and the charge is 5%, your initial investment will be $95,000. Your advisor/dealer will also earn 1% (a.k.a. a trailing commission) each year which is explained in more detail below. I don’t know of an advisor that charges a client a FEL fee and, from what I have seen, it is common practice for advisors to provide FEL funds with a 0% commission. You could have asked for this option rather than the DSC, if you knew it was available to you. There is no penalty to redeem from an FEL fund.
DSC funds, on the other hand, provide a way for the advisor to earn the 5% commission without it coming out of your initial investment. If you make a $100,000 investment, the mutual fund company will pay the advisor’s dealer/employer 5% of the original investment, or $5,000 in this case. Generally, the advisor’s dealer will keep 20% of the $5,000 and the remaining $4,000 is passed along to the advisor.
But that’s not all.
Redeeming mutual funds
The advisor/dealer is also paid an annual trailer commission of 0.5%, pro-rated monthly based on your current investment value. In this case $500 minus the 20% to the dealer being $400. Your full $100,000 is invested, but the fund company needs you to keep invested for at least seven years, so it has time to recoup the commission it paid to your advisor/dealer.
If you decide to redeem your investments from the fund company before the seven years are up, you will be charged a penalty, which reduces each year until the DSC maturity date when you are free to withdraw your investments without penalty. There are differences between the fund companies as to how the penalties are applied so it is best to check their respective prospectus.
And, remember, if you are making monthly contributions into a DSC fund, each new contribution is locked in for another full six years before it can be withdrawn without a penalty.
Can you redeem mutual funds without paying a penalty?
Luckily, there is a way to get some money out of mutual funds without penalty, there has to be. Imagine if you were retired and had to pay a penalty every time you drew on your account.