A CDSC, or contingent deferred sales charge, is a fee that mutual fund investors holding a certain type of shares must pay to fund houses when the shares are redeemed.
This fee, also called a sales charge or a back-end load, is applicable to Class-B fund shares for a specific number of years from the date of purchase. These fees decline every year until the shares are held and eventually become zero. This period generally lasts anywhere between 5 and 8 years since the purchase.
In this article, we will understand what contingent deferred sales charge is and CDSC’s meaning and see an example of CDSC to understand its fee structure and importance.
What is a Contingent Deferred Sales Charge (CDSC)?
A contingent deferred sales charge is a fee that investors need to pay upon redemption of Class B mutual fund shares. This back-end sales charge or load depends on the holding period of the shares by the investor. This fee declines every year that the shareholder holds on to these shares and eventually becomes zero after 5–8 years of purchase. Understanding how contingent deferred sales charge (CDSC) works is important for an investor as it helps them decide which class of shares align with their financial goals and the fees they must pay.
If the shares are sold quickly after acquisition, the costs associated with it will be higher. Mutual fund companies impose these charges to recoup the cost of selling the fund.
Contingent deferred sales charges are generally calculated as a percentage of the entire value of the shares. They also vary depending on the type of fund. Hence, it is important to understand how they work before investing.
How does CDSC work?
The contingent deferred sales charge is different and unique for every mutual fund and is charged based on the redemption of Class B mutual fund shares. The fee or sales charge does not require any advance payment. It is charged based on a sliding scale up until they are redeemed to incentivise the investor to hold on to the shares for longer. The longer the investor holds the funds, the lower the charges.
For example, let us take a certain CDSC with a schedule of 7%, 6%, 5%, 5.5%, and 4%. Now, if an investor redeems their class B mutual funds in the very first year, they will have to pay a redemption fee of 7%. If the shares are redeemed in year 2 of holding, the fees will be 6%, which will continue to decrease with every passing year. According to the above CDSC schedule, an investor will not be required to pay any redemption fees after five years.
CDSC fee structures in different share classes
Investors have the choice to select shares from any of the given mutual fund share classes.
Class A: These shares have a front-end load, which requires the investor to pay a sales charge up-front.
Class B: These do not have any up-front sales charges but attract a sales charge in the form of CDSC when the shares are sold.
Class C: These shares have comparatively low fees in the form of front-end or back-end load and generally have a fixed fee that is charged on redemption.
In all the above share classes, whenever a fund load is levied, it is a way for the broker or financial advisor to get a sales commission.
When deciding which share class to choose, the amount of investment required and the expected holding period should be the two most important factors to consider. Once you have decided which share class to opt for, your investment broker may also reduce the fees or sales charge if you decide to invest a significant amount.
Effects and purposes of contingent deferred sales charges
Contingent deferred sales charges are a measure to discourage shareholders from trading their class B mutual funds actively. This trading action would require mutual funds to have higher liquidity and keep cash on hand ready when shares are sold. Many experts believe that the CDSC is actually compensation for the expertise of the broker in selecting the right funds for the investor that aligns with their goals.
Mutual fund prospectus has made it mandatory to disclose all types of charges and fees, like the CDSC, to ensure that investors are aware of all the costs associated with a mutual fund. This will help potential investors to thoroughly evaluate the expenses that they will have to incur when they purchase a mutual fund unit and make decisions based on their risk appetite and maturity horizons.
Why is CDSC important for investors?
An understanding of contingent deferred sales charges is important for investors as it can help them make a well-informed decision before investing. An investor must look at all the fees and charges that they might have to bear as it has a significant impact on the returns generated by their investments.
It is also important to consider the performance of the funds when evaluating options since funds that generally deliver higher returns may also charge a higher CDSC.
Example of CDSC
To understand CDSC with more clarity, let us consider an example where an investor is interested in making a mutual fund investment of Rs. 48 lakhs. Since they do not want to pay any fees or sales charges upfront, they decide to buy class B shares. The contingent deferred sales charges schedule for these shares is 8%, 6%, 4%, 2%, and 1%.
This translates to a holding period of at least 5 years, and if the shares are sold before this period, the investor will have to bear CDSC charges. Once the holding period is 7 years, these Class B mutual fund shares will automatically be converted to Class A shares, reducing operational expenses.
The investor intends to hold these shares as a long-term investment but is forced to liquidate a portion of their mutual fund Class B holdings in the fourth year due to financial constraints. Now, the sales charge applicable in the fourth year is 2%. If the investor liquidates Rs. 15 lakhs, they will have to pay a CDSC of Rs. 30,000 on the sale of these class B mutual funds.
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Key takeaways
- A contingent deferred sales charge, or CDSC, is applicable on class B mutual funds and paid as a back-end sales charge during a specified period within which an investor is supposed to hold on to the investment.
- A good knowledge of CDSC enables investors to understand these charges in detail and make informed decisions about investing.
- Investors can bypass up-front sales charges by holding their shares until the CDSC period expires. However, during this time, they will incur higher annual fees.
Conclusion
Understanding the nuances of contingent deferred sales charges (CDSC) is crucial for investors looking to make informed decisions about their mutual fund investments. CDSC serves as a mechanism to encourage long-term holding of Class B shares by imposing a declining fee structure over a specified period. This helps mutual fund companies manage liquidity while ensuring investors align their investment strategies with their financial goals.
Being aware of these charges, their implications, and how they vary across different share classes can significantly impact the overall returns and investment experience.
For those seeking a comprehensive and user-friendly platform to manage their mutual fund investments, consider exploring the schemes on the Bajaj Finserv Mutual Fund Platform. Whether you are a seasoned investor or just starting out, the Bajaj Finserv Platform offers a wide variety of mutual fund schemes to maximise your financial growth.
