ARTICLE: The High Cost of Owning Load Funds

When it comes to investing in mutual funds, there are basically two flavors: Load funds and no-load funds. When you invest $10,000 in a no-load fund, there is no sales commission and the entire $10,000 invested goes to work for you. In a load fund, a sales commission is subtracted from your investment. Invest $10,000 in a fund with a 5.75 percent front-end load (this is the usual arrangement for class A shares), and only $9,425 is invested for you. That's what your account will be worth at the end of the first day you own the fund.

Another common type of load fund is class B shares. Unlike class A shares which are fairly straightforward, class B shares are a bit more complicated, and in many cases can be a bit more deceiving, than Class A shares. Many commissioned advisors and brokers will tell you that there is no front-end sales charge; and that all your money goes to work for you right away, which is true. However what many advisors and broker fail to mention is that they also receive a commission from the fund company for selling you the fund. To pay for this upfront commission, the fund company now charges the shareholders a back end sales load should they decide to exit the fund within a certain time period. A typical example is a 5% back-end sales load that decreases by 1% percent each year until the sixth year. If you don't sell the mutual fund by then, you don't have to pay the back-end load at all. Sounds like a win-win for the broker and the investor right? Wrong. In addition to decreasing the sales load by 1% each year, the fund company also passes on an additional annual expense of 1% to each shareholder during this period as well. Now if the shareholder doesn't sell and pay the back end sales load, the additional annual expense of 1% over this six year period will cover the sales rep commission paid out in year one. Because of these higher fees, investors can actually end up earning less money over the long term than if they paid the front end load on an A share fund.

While not all funds have sales loads, all mutual funds do have ongoing management expenses. These include all the normal costs to run a fund and support existing shareholders: accounts, custodians, lawyers, transfer agents, printing statements, taxes, and so forth. On the whole, expense ratios range from as low as 0.2% for no load index funds to as high as 2.25% for class B share funds.

In the following hypothetical example, assume you put $50,000 into each of following three funds with an average return of 10 percent before expenses and commissions: 1.) a class A share fund with a front-end load of 5.75 percent and expense ratio of 1.0 percent, 2.) a class B share fund with an expense ration of 2.25 percent, and 3.) a no-load fund with an expense ratio of .50 percent. After 25 years, an investor in the no-load fund would have an account worth $483,418 while an investor in the class A and B share funds on the other hand, ended up with only $406,363 and $390,540 respectively (see chart). That's $135,372 and $151,195 less than the no-load fund with exactly the same average return. The difference in the ending dollar value is entirely the result of the sales commissions and higher expenses of the load funds.

The Impact of Expenses and Commissions

Sales Load Exp. Ratio	No Load Fund None 0.5%	Class A Fund 5.75% 1.0%	Class B Fund None *2.0%
Day 1	$50,000	$47,125	$50,000
1 yr	$54,750	$51,366	$54,000
5 yrs	$78,712	$72,508	$73,466
15 yrs	$195,066	$171,652	$168,800
25 yrs.	$483,418	$406,363	$390,540
Expenses	$58,317	$135,372	$151,195

* Fund expense ratio reduced to 1.25% after year six.

The fact is that besides load funds charging a sale's fee and no-loads funds not, there is absolutely no difference between the two. Load funds don't attract better money managers than do no-load funds. Load funds don't have lower annual expense ratios than no-load funds. When you buy shares of a load fund, you don't get free frequent flier miles. So why would any person ever want to invest in a load fund? If there were two electronics stores side by side and both sold the exact same television only one charged 5.0% more to compensate the sales people, at which store would you buy your TV? With such a wide variety of no-load mutual funds available today, most investors should never pay a sales load.

If paying high expenses and commissions normally brought a premium return that investors could count on, then paying those higher expenses commissions would make sense. However, every study that I am familiar with on mutual fund performance shows exactly the same thing: Paying above -average expenses makes above-average performance less likely, not more likely. The reason is simple: Expenses don't enhance performance, they erode it. Every $1 you unnecessarily pay or lose now costs you not only that $1, but also the amount that $1 could earn over your investment lifetime.

Consider this, making a $50,000 investment in a fund with 5.75% load would translate into the equivalent of more than 14 hours of portfolio planning undertaken by a fee-only advisor at $200 per hour! If you were to hire an advisor for 14 hours at that rate, you could expect him or her to accomplish a great deal of work that would produce a more balanced portfolio, returning a potentially higher rate than the loaded mutual fund.

Copyright (c) 2006, Capital Wealth Management. All Rights Reserved.