Deferred sales charge: Overview, definition, and example
What is a deferred sales charge?
A deferred sales charge (DSC) is a fee that is charged to investors when they sell or redeem certain investment products, such as mutual funds or annuities, within a specified time period after purchasing them. Instead of being paid upfront, the charge is deferred and deducted from the value of the investment when the investor exits or withdraws from the investment before the end of the specified holding period, typically ranging from 3 to 7 years.
For example, if an investor purchases a mutual fund with a deferred sales charge and decides to sell the investment within the first five years, the mutual fund company will impose a percentage fee on the value of the shares being sold.
Why is a deferred sales charge important?
The deferred sales charge is important because it helps discourage short-term investing and encourages investors to hold their investments for a longer period. It can also help compensate financial advisors or institutions for the services and costs associated with selling the investment.
For investors, understanding the deferred sales charge is crucial when making investment decisions, as it can significantly impact the returns if the investment is sold prematurely. For financial institutions or fund managers, this charge helps recoup marketing or distribution costs and ensures that clients stay invested for a minimum period.
Understanding deferred sales charge through an example
An investor purchases a mutual fund with a deferred sales charge of 5%, which applies if the investor sells the shares within the first three years of holding them. After two years, the investor decides to sell their investment, which has appreciated to $10,000. The mutual fund company imposes a deferred sales charge of $500 (5% of the $10,000), and the investor receives $9,500 upon sale.
In another example, an individual purchases an annuity with a deferred sales charge of 7%. If the investor decides to redeem the annuity within the first four years, the 7% fee would be deducted from the annuity’s value. If the annuity’s value at redemption is $100,000, the investor would incur a $7,000 fee.
An example of a deferred sales charge clause
Here’s how this type of clause might appear in a contract or investment agreement:
“In the event that the investor redeems or sells their shares in the Fund within the first [X] years of purchase, a deferred sales charge of [Y]% will be applied to the amount redeemed or sold. The charge will decrease progressively based on the length of time the shares are held.”
Conclusion
A deferred sales charge is a fee that applies when an investment is sold or redeemed before a specified holding period expires. It discourages early withdrawals and ensures that financial institutions or advisors are compensated for their services. For investors, understanding the deferred sales charge is important when evaluating investment products to avoid unexpected costs and ensure their investment strategy aligns with the holding period.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.