Mutual funds are diversified investments that can hold hundreds of different securities. They are primarily intended for long-term investment. As a result, some funds charge a penalty for short-term sales. Other funds may charge penalty fees for sales made years after your initial purchase. The share class you purchase is the prime determinant of the penalty you pay. Mutual fund sales may also generate tax liabilities.
When you take money out of a Class A mutual fund, you won't be charged any penalties. Class B and C, however, both charge a penalty based on the year you make the withdrawal.
Front-End Load Funds Referred to as Class A Shares
When mutual funds were first invented, the only way to purchase them was to pay an upfront sales charge at the time of purchase. To differentiate front-end load funds from the other types of funds that exist today, front-end load funds are usually referred to as Class A shares. Since you pay the fund commission at the time of purchase, you don't have to pay any penalty when you sell an A share fund.
Back-End Load Funds are Class B Shares
Funds with a back-end sales charge are referred to as Class B shares. Class B shares don't charge you anything at the time of purchase but carry a "contingent deferred sales charge" that you have to pay if you sell your shares within a certain period, typically six years. This charge generally decreases from year to year, so you might get charged 6 percent if you sell the fund within the first year of ownership, 5 percent in year two and so on down to zero after six years.
Level-Load Funds are Known as Class C Shares
Class C shares are also referred to as level-load funds. As with B shares, C shares charge you nothing upfront. However, the annual expenses of C shares are usually higher than both A shares and B shares, particularly over the long run. C shares often charge a 1 percent redemption fee if you sell the fund in the first year after you buy it, with no charges after that one-year holding period.
No-Load Funds Do Not Have Shares
True no-load funds do not have share classes. A no-load fund will not generally cost you anything to either buy or sell. However, some "no-load" funds do charge redemption fees for sales. These redemption fees are limited to 2 percent by the U.S. Securities and Exchange Commission.
Mutual Funds Traded Like Stocks are Exchanged-Traded Funds
Some mutual funds trade like stocks on an exchange rather than being issued by individual mutual fund companies. These types of mutual funds are known as exchange-traded funds. As with stocks, you pay a commission to buy or sell an exchange-traded fund. There are no additional penalties or sales charges to sell an ETF beyond the regular stock commission.
How Taxes Work With Mutual Funds
As with other capital assets, you'll have to pay taxes on any gains you realize when you sell a mutual fund. If you hold a fund for one year or less, you'll have to pay ordinary income tax on your gains. Funds sold at a profit after one year are taxed at the more favorable capital gains tax rate.