Mutual Fund Sales Loads

Those who deal in mutual funds, much like the clients investing with them, are out to make money. There are a variety of different ways they do this, and one of them is through something called a sales load. Sales loads aren’t applicable to all mutual funds, as no-load funds do exist (as we shall discuss later), but when a broker recommends a fund for clients to buy, chances are it will be a load fund since it would be in their interest to recommend one. Sales loads essentially function as a commission, and are valued at a certain percentage of the actual investment amount.

Sales loads come in several varieties. The first is the front-end load. This type of load is quite easy to understand. The way that it works is to have a given percentage charged immediately upon purchase. The maximum sales load allowable by law is 8.5%, although most sales loads are smaller than that.

mutual-funds-glasses-newspaperAnother type of sale load is the back-end sales load. These are also sometimes known as deferred loads. Back end sales loads are fees that are charged upon the sale of the investment rather than when you buy it. This let’s all of the money work for you and benefit from compounding from the very beginning. Some of these back end sales loads have provisions in them which either reduce or completely eliminate the fees if you keep it for a certain length.

Finally, there’s something known as a level load. Level loads are ongoing management fees instead of having a fee upon buying or selling. By law, these are capped at 1% annually, but will typically be around .25%. These allow those who manage the fund to benefit from the effect of compounding. This makes level loads potentially the most costly, depending on how long it’s held.

A very important piece of information to keep in mind is that you should vastly prefer no-load mutual funds to funds with a load attached. Historically, no-load funds outperform load funds, especially when adjusted for the fee itself. Keep in min that your losses are not only limited to the 5% or so load itself, but the opportunity cost of all the lost compounding on that investment. So unless you have a particularly strong reason to opt for a fund with a load, stick with no-load mutual funds.

The Impact of Expense Ratios on Investment Performance

The basic idea behind investing is to grow your assets, of course. However, there are certain factors involved in the entire investment process that can take a chunk out of your expected investment returns. Investment fees are one notorious factor, so we decided that we’d look through some of the basics on expense ratios and their potential impact on investment performance.

With a vast array of mutual funds and ETFs to choose from, one of the most important things to consider in terms of long-term gains is the expense ratio. This is separate from the load, which some funds charge and when the investment is made in order to compensate brokers.

Compounding is one of the most important aspects to investing, and it’s also why investing early in retirement is important. A good way to think about expense ratios is to picture them as compounding in reverse. If you lose even 1 percent every year, that adds up significantly. Expense ratios are so important that Russel Kinnel, Morningstar’s director of mutual fund research, said that “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.”

To illustrate just how impactful it is to be selective with expense ratios, I ran them through a calculator (those of you wishing to do your own calculations can do so here). Let’s say you invested $50,000 in a fund that gives a return of 8%. Disregarding any other sales loads, fees, taxes, etc, this chart illustrates precisely what your investment will look like at various points in time.

2013-08-23

As you can see, the numbers are quite significant. A difference of half a percentage point, over time, could reduce your ending value equal to your entire original investment amount (or even more if this chart went beyond 30 years)! This just further sends home the message that, in the long run, the expense ratio of your funds is one of the most important things to consider.