What are no-load mutual funds?
Copyright 2006 Michael Saville
No load mutual funds are mutual funds whose shares are sold
without a commission or sales charge. The reason for this
is that the shares are distributed directly by the
investment company, instead of going through a secondary
party. This is the opposite of a load fund, which charges a
commission upon the initial purchase at the time of sale.
Since there is no cost for you to enter a no-load fund, all
of your money is working for you. If you purchase $10,000
worth of a no-load mutual fund, all $10,000 will be
invested into the fund. On the other hand, if you buy a
load fund that charges a commission of 5% upon purchase,
the amount actually invested in the fund is $9,500. If both
funds return 10%, the no-load fund would have grown to
$11,000 while the loaded fund only rose to $10,450.
The major idea behind a load fund is that you will make up
what you paid in commissions with the solid returns that
the managers will provide. However, most studies show that
loads don't outperform no-loads.
Most load mutual funds are sold through brokerage houses,
financial planners, and people known as "Registered
Representatives." With very few exceptions, most of these
people operate on the basis of selling as many fund shares
as possible. Their commissions are collected up front, as a
back end charge, or both. Whether you make money or lose it
isn't their primary concern. What matters most to these
folks is how often you buy (and generate new commissions
for them).
No load funds have traditionally been marketed directly by
the mutual fund companies themselves. But today, more and
more funds are being offered through discount houses like
Fidelity, Schwab, and a host of others. The advantage to
this is that you have an unlimited choice of mutual funds
in one place. You don't have to open a separate account for
each mutual fund family that you purchase.
Most fee based investment advisors have independent
relationships with the major discount firms. They're able
to offer clients just about any no load mutual fund that is
available. They receive no commissions from the firm and
only get paid by the client according to a pre-determined
fee arrangement. Under this type of arrangement, there's no
hidden agenda to try to sell you a particular mutual fund
in order to earn a larger commission.
It is best to stick with no-load or low-load funds, but
they are becoming more difficult to distinguish from
heavily loaded funds. The use of high front-end loads has
declined, and funds are now turning to other kinds of
charges. Some mutual funds sold by brokerage firms, for
example, have lowered their front-end loads to 5%, and
others have introduced back-end loads (deferred sales
charges), which are sales commissions paid when exiting the
fund. In both instances, the load is often accompanied by
annual charges.
On the other hand, some no-load funds have found that to
compete, they must market themselves much more
aggressively. To do so, they have introduced charges of
their own.
The result has been the introduction of low loads,
redemption fees, and annual charges. Low loads--up to
3%--are sometimes added instead of the annual charges. In
addition, some funds have instituted a charge for investing
or withdrawing money.
Redemption fees work like back-end loads: You pay a
percentage of the value of your fund when you get out.
Loads are on the amount you have invested, while redemption
fees are calculated against the value of your fund assets.
Some funds have sliding scale redemption fees, so that the
longer you remain invested, the lower the charge when you
leave. Some funds use redemption fees to discourage
short-term trading, a policy that is designed to protect
longer-term investors. These funds usually have redemption
fees that disappear after six months.
Probably the most confusing charge is the annual charge,
the 12b-1 plan. The adoption of a 12b-1 plan by a fund
permits the adviser to use fund assets to pay for
distribution costs, including advertising, distribution of
fund literature such as prospectuses and annual reports,
and sales commissions paid to brokers. Some funds use 12b-1
plans as masked load charges: They levy very high rates on
the fund and use the money to pay brokers to sell the fund.
Since the charge is annual and based on the value of the
investment, this can result in a total cost to a long-term
investor that exceeds a high up-front sales load. A fee
table is required in all prospectuses to clarify the impact
of a 12b-1 plan and other charges.
The fee table makes the comparison of total expenses among
funds easier. Selecting a fund based solely on expenses,
including loads and charges, will not give you optimal
results, but avoiding funds with high expenses and
unnecessary charges is important for long-term performance.
About the Author:
Michael Saville has over twenty five years experience in
providing finance and investment advice. He has written a
free five-part short course on 'no load mutual funds' which
is available at http://www.buy-mutual-funds.com
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