A no-load mutual fund is an investment whose shares are sold without commissions or sales charges. Since there are no costs of entry, the entire investment is immediately put to work. But how do the returns of no-load funds stack up against those that charge fees?
Mutual Fund Fees
Most brokers are likely to recommend mutual funds that charge a fee or load. The logical explanation will be that funds that charge a fee are trying to be "exclusive," and are able to demand a premium from the "serious" investor. Behind the scenes, the broker is getting a slice of the fee as part of their sales commission arrangement with the mutual fund.
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In general, there are four types of mutual fund loads that an investor might encounter in the marketplace:
Front-End Loads: money is paid, or fees are levied, at the time of purchase and payable to the broker.
Purchase Fees: money is paid, or fees are levied, at the time of purchase and payable to the mutual fund's management team.
Back-End Loads: money is paid, or fees are levied, when shares of the mutual fund are sold. This money is typically paid to the broker.
Redemption Fees: money is paid, or fees are levied, when shares of the mutual fund are sold. This money is typically paid to the mutual fund's management team.
There is often confusion about mutual fund management fees versus sales fees or loads. As is true with any business, it costs money to run a mutual fund. There are trading costs, share exchanges, redemptions, as well as the cost of salaries paid to the persons responsible for actively managing and administrating the fund.
These fees are relatively small charges, and are a function of the conveniences an investor gets when buying into a mutual fund; these are not loads. This type of fee would be referred to as a fund expense, and is normally indicated on the prospectus in the form of an expense ratio.
Performance of No Load Funds
Not that long ago, Morningstar, reported that no-load mutual funds actually outperformed mutual funds charging a load or fee over a 3 to 5 year timeframe. Let's take a look at a relatively simple example that should help explain why this is true.
The most common fee associated with load funds is an upfront sales fee, or a front-load. Typically, these fees range from 2.5% to 8.0%, with 5.0% being the most common fee. If an individual were to invest $20,000 into this fund, they would be starting out with only $19,000 in their account. What did the investor get for that $1,000 sales fee? They received the "benefit" of starting out with an immediate 5.0% loss!
That $1,000 fee is not going towards the management of the fund. It's also not going to get the individual into any exclusive club of investors. It is simply a commission that is split between the broker and perhaps several other individuals that are involved with the handling of the transaction.
Short-Term Investments
The impact of a front-end load on the fund's return on investment is particularly significant for short-term investments; specifically, those held for three years or less. It's extremely difficult for any mutual fund, with the same investment strategy as a no-load fund, to make up the money lost to fees in such a short timeframe. This is another reason why knowledgeable investors choose no-load mutual funds.
Hopefully, this article should make one factor very clear: No-load mutual funds maximize an individual's ability to grow their investment. Mutual funds carrying a load don't always outperform no-load mutual funds, and research suggests they actually underperformed the competition. Look at the facts and don't fall for a slick sales pitch. The only thing someone investing in mutual funds needs to know about loads is to stay away from them.
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