If you've ever searched for information on mutual funds, you've undoubtedly come across articles espousing the benefits of no-load mutual funds. These are funds that allow investors to limit the fees they pay by cutting out the middlemen, notably investment advisers and brokers. Most authors writing about the merits of no-load funds base their arguments primarily on fees and even performance, but they rarely delve into some of the personal reasons to select an investment.
In this article, we explain the difference between load and no-load mutual funds, and explore the reasons investors may prefer a load fund despite its apparent economic disadvantages.
- Investors can choose to purchase units in no-load or load mutual funds.
- No-load mutual funds have no or low fees while load funds have a sales charge or commission attached.
- You can purchase no-load funds directly from the company or through a brokerage firm but load funds are sold through an adviser.
- Some studies show that no-load funds outperform load mutual funds.
- If you don't trust your own judgment or have an existing relationship with a financial professional, you may want to consider load funds.
What Are Load Mutual Funds?
Load funds are mutual funds you purchase from your adviser or broker that have a sales charge or commission attached. The charge goes to pay the intermediary for his or her time and expertise in selecting the appropriate mutual fund. These funds normally have a front-end, back-end, or level sales charge, depending on the particular class of share purchased.
For example, A-shares normally have front-end sales charges paid at the time of the initial purchase while class B shares have back-end sales charges paid when selling the shares within a specified number of years.
A load fund may also have a 12b-1 fee. This is a fee associated with annual marketing or distribution for a mutual fund, which can be as high as 1% of a fund's net asset value (NAV). The Financial Industry Regulatory Authority (FINRA) limits 12b-1 fees to 0.75% and also limits 12b-1 fees used for shareholder services to 0.25%.
What Are No-Load Mutual Funds?
Investors obtain no-load mutual funds at NAV without any of the front-end, back-end, or level sales charges. People purchase shares either directly from a mutual fund company or indirectly through a mutual fund supermarket.
No-load funds may have a small 12b-1 fee (the cost of distribution), which is incorporated into the fund's expense ratio. A shareholder pays for the expense ratio on a daily basis through an automatic reduction in the price of a fund. FINRA allows a mutual fund without any sales charges to have 12b-1 fees up to 0.25% of its average annual assets and still call itself a no-load fund.
Some funds can charge a 12b-1 fee and still call themselves no-load funds.
There are many no-load funds available that don't charge 12b-1 fees when purchased directly from a mutual fund company. They are often referred to as true no-load mutual funds. These differ from the supermarket funds that often have the 12b-1 fee.
Fee-conscious investors seek out mutual funds with lower expenses, which they believe will outperform higher-priced mutual funds over time because the fees won't eat away at the overall net return.
The No-Load Performance Advantage
There are several obvious advantages when it comes to investing in no-load mutual funds. The first, and most obvious, is that they come with no (or low) fees. This means that more of your capital is invested rather than going into the pocket of an adviser or mutual fund company.
You also have more control over your investment(s). Because load funds are purchased through an adviser or financial planner, you may have to deal with recommendations from the professional in charge of your portfolio. That isn't always the case with a no-load fund since you can purchase units in funds on your own.
There are plenty of studies conducted by analysts to determine how well no-load funds do compared to load funds. Some believe that the performance of load funds outpaces that of no-load funds because the former have advisers. But there are instances where the reverse is true—that no-load funds outperform the ones that come with fees. For instance, a 2003 study showed that no-load mutual funds significantly outperformed load funds between 2000 and 2002.
Why Would Anyone Buy a Load Mutual Fund?
On the surface, it seems that all investors would be better off buying no-load mutual funds. After all, who wants to pay a charge if you really don't have to? But there are other reasons why a person would be better suited to the load mutual fund group. Here are just a few:
- Many people do not feel comfortable making investment decisions and will not invest without the help of a financial adviser. Financial advisers often persuade people to follow through on investment programs that are in their best interests.
- Thoughtful investment decisions require research, and many people lack the time needed to do their own research. Finding the time to manage investments can be extremely challenging.
- Some investors have an existing relationship with a broker or a financial adviser and do not want to damage that relationship by pursuing investments on their own. They may also prefer the one-stop shopping that a financial adviser can provide.
- Many people want someone to blame when a problem occurs with one of their investments.
- Some investment professionals argue that brokers and financial advisers are able to keep their clients from making rash decisions during turbulent market periods. The argument is that no-load mutual fund investors are far more likely to sell their investments at exactly the wrong time.
The Bottom Line
There's no doubt about the fact that investments that come with no fees are a popular choice for cost-conscious investors. But despite the fees and, by extension, the inferior returns, load funds can still be a good investment, especially for inexperienced or very busy investors. Ultimately, it will be for you to decide whether the services you receive are valuable enough to justify giving up the higher returns of a no-load mutual fund.