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CDSC: Contingent Deferred Sales Charge Explained

Updated: Mar. 22, 2022By: Kimberlee Leonard

The contingent deferred sales charge, called a CDSC or a "back-end load", is a fee that is charged by mutual fund companies on certain classes of shares when you sell or redeem them. It is a fee that usually declines each year you hold the fund's shares until it eventually reaches zero – usually between five to eight years from your purchase. Understanding the CDSC will help an investor decide which class of shares to purchase when investing in a mutual fund.

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CDSC and Mutual Funds

Contingent deferred sales charges are unique to mutual funds, so just to refresh you from our article on funds, "a mutual fund is a financial vehicle managed by investment companies that pool cash from a variety of investors and invests that money for them. Mutual funds are available in a broad number of asset classes but are most commonly used as stock, bond, commodity, and short-term debt funds."

What a Contingent Deferred Sales Charge Is

Over the decades that mutual funds have been around, they have yielded to public pressure to reduce their upfront sales charges. One answer to that was to introduce "breakpoints" which reduce the up front sales charges for larger initial investments. Another answer has been to create multiple share classes with alternative fee structures, offering investors the choice of which structure suits them the best. One of these structures is a contingent deferred sales charge or CDSC.

All mutual fund share classes are investments in the same underlying portfolio and all investors pay a share of the expenses of the fund. What the fund companies have done by offering different share classes is allow investors the choice of paying a reduced sales charge, or even none at all, in return for paying a higher share of the annual expenses every year. Investors can choose which class of fund shares they prefer.

The expenses charged to investors in a mutual fund consist of the investment management fees plus costs associated with distributing and marketing the fund to the public. Marketing expenses, which are also called "12b-1" fees after the clause in the Investment Company Act that allows them, can be different in each share class. Together, these costs are measured as a percent of fund assets and disclosed to investors as the expense ratio or management expense ratio of the fund.

The sales charge for different classes can take the form of an up-front sales charge ("front-end load"), a redemption fee ("back-end load"), or a contingent deferred sales charge. The CDSC is a type of redemption fee that is contingent upon how long you have owned the shares.

Three share classes of mutual funds are generally available to investors as follows:

  • Class A -- Shares subject to an up-front sales charge
  • Class B -- Shares subject to a CDSC
  • Class C -- Shares subject to a fixed redemption fee

Additional share classes may also be available with even lower sales charges for high net-worth individuals and institutional investors. Each of the three share classes above will likely have a different expense ratio. Generally, the share classes with higher sales charges have lower expense ratios and those with lower sales charges have higher expense ratios. The mutual fund companies are going to get fees one way or another -- it's up to the investor to make the trade-off between the three share classes when making an investment.

Takeaway: Mutual funds are generally available in multiple share classes, which allow investors to choose between fee structures. Higher sales charges are generally associated with lower annual expense ratios but other considerations include the size of the investment and how long the investor expects to hold the shares. To keep their overall sales charges and annual expenses as low as possible, investors need to understand the tradeoffs of the different share classes available.

How Contingent Deferred Sales Charges Work

The CDSC found in class B shares of a fund comes into play when you redeem the shares with the fund company. Instead of paying a sales charge up front, the sales charge is levied upon redemption with a sliding scale that reduces for each year you have owned the fund. For example, a CDSC schedule of 5%, 4%, 3%, 2%, and 1% means shares redeemed within one year are subject to a 5% redemption fee, shares redeemed the second year are subject to a 4% redemption fee, and so on. In this CDSC schedule, the investor can redeem shares after five years with no redemption fee.

However, class B shares will have a higher annual expense ratio than class A shares, so your tradeoff for being able to have no sales charges after five years also means you will pay a higher annual fee for those years.

One rule from FINRA that helps investors says that Class B shares must be converted to Class A shares within two years after the CDSC is eliminated. So if the Class B shares have a six year CDSC fee schedule, the shares must convert to Class A by year eight. This affords class B shareholders the ability to realize the lower expense ratios in A shares from that point on.

The CDSC calculation is straightforward. The sales charge for the year of redemption is multiplied by the amount being liquidated. For example, investors with a CDSC of 4% in year two and liquidating $100,000 will pay $4,000 in sales charges. Most mutual funds have Class B shares with a CDSC between five and eight years. The fees often start at 5% or 6% and decline steadily over the time frame.

Class B shares do not have breakpoints like Class A shares often do. A breakpoint is a reduction in sales charge for investing more than a certain amount of money. For example, a Class A share may reduce the 5.75% front-end sales charge to 4.5% if you invest more than $25,000. The more you invest, the less you pay, with a $1 million investment often having no sales charge at all. Investors buying large sums of mutual fund shares should always consider breakpoints in deciding what class of shares to buy.

Minimizing Total CDSC Charges

Once an investor has selected a fund to invest in, the question of which share class to purchase will thus depend on how much they are investing and how long they expect to be in the fund. The fund's prospectus will outline all the share class options and describe all sales charges, potential breakpoints, CDSCs, redemption charges, and expense ratios that are associated with the various share class options.

The task is then a matter of adding the appropriate sales charges and expense ratios for each share class over the number of years the investor expects to hold the fund. If the length of the investment is uncertain, an investor might select several time periods and check them all. Chances are that there could be some significant differences in the total sales charges and expenses of the different share classes.

Tip: Investors may be able to save considerable money in fees over the life of a mutual fund investment by selecting the optimal share class. It pays to study the fee structures of the different share classes offered in the prospectus to determine which will be most cost effective for the length of time the investor expects to own the shares.

CDSC Example

John buys $50,000 worth of a mutual fund. His investment advisor reviews the breakpoints for Class A shares with John, but John prefers to pay nothing up front and buys Class B shares instead. The CDSC schedule is 5%, 5%, 4%, 3%, 2%, 1% which means that John has to hold the fund for at least six years to avoid paying a sales charge. At year eight, his fund will automatically convert to Class A shares with the lower operating expenses.

John intends for this to be a long-term investment with a time horizon of 10 years. However, in year three, he runs into financial difficulties and needs to liquidate part of his mutual fund investment. He sells $10,000 of his Class B shares. Being in year three, this means he is at the 4% sales charge. He must pay $400 when liquidating $10,000 of his mutual fund.

Bottom Line

The CDSC is a graduated back-end sales charge paid on Class B mutual fund shares that is contingent upon how long the investor has held the shares. While an investor can avoid paying any sales charges at all by holding the shares past the CDSC expiration, they will also be paying higher annual expenses in the meanwhile. Investors should therefore review the fund prospectus carefully to fully understand the sales charges and annual expenses associated with the various share classes offered.

This article was written by

Kimberlee Leonard profile picture
Kimberlee brings professional experience to her writing. She started as a FINRA Series 7 broker and later transitioned her career into owning an insurance agency and preparing taxes.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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