You've probably heard of a no-load mutual fund. You might have even purchased one in the past. Notice, however, that you never hear of "load" mutual funds. But why would you? It's not good business for someone who wants to charge you a lot of money to give you the opportunity to ask:
1. What's a load?
2. Is it worth it?
3. Can I buy a fund without a load?
Here are the short answers:
1. A load is a hefty sales commission.
2. No.
3. Yes, and you can buy a better fund at that.
There's no beating around the bush here. No-load funds are the only way to go.
Build a better portfolio
Here are a few more facts you should know about loads.
With a loaded fund, you may also find a 12b-1 fee. This fee is paid out of a fund's assets and can be used to cover costs such as advertising, distribution of fund literature, and even sales commissions to pay brokers. Consider the conflict of interest here: The fund "pays" the broker to assure that the fund remains at the top of his or her recommendation list.
Loads understate the true commission being charged. A 6% load paid on a $10,000 investment creates a commission of $600, leaving you with only $9,400 left to invest. If you recalculate the commission as a percentage of your remaining investment, you'll find that the load is really closer to 6.4% (as if 6% weren't hefty enough).
The effect of the load, if paid up front, is not diminished as quickly as the fund company (and your broker) would have you believe. If the money you paid for the load had been working for you the whole time, as it would have in a no-load fund, it would have been compounding.
It just gets worse and worse .
Funds with loads also tend to have different share classes. Of these, A-class shares tend to have a bad reputation. In all fairness, though, A shares may have certain break points, or points at which the sales charge is reduced. For example, American Funds Growth Fund of America (AGTHX) -- a popular large-cap offering whose top holdings recently included Texas Instruments
B-class shares, on the other hand, have a back-end load, which is triggered when you sell the fund. This load can disappear over time, thus making the B shares appear better than the A shares for a long-term buy-and-hold investor. However, buyer beware. B- and C-class shares have much higher expense ratios -- often as much as a full percentage point higher. And lest we forget, the extra expense ratio is the gift that keeps on giving ... to your broker.
Are loads worth it?
You're wondering: These loaded mutual funds, they're probably better funds, right? No. Fund managers make funds. And unless you can tell me that these loaded funds are able to somehow get the better managers, there is absolutely no validity to those claims.
To wit, compare the holdings of a fund with a front-end 5.75% load, Dreyfus Premier Structured Midcap A (DPSAX), and Vanguard Strategic Equity (VSEQX), which carries no load. You'll find some similarities, including positions in consumer discretionary companies American Eagle Outfitters
Nevertheless, over the prior three-year period, Strategic Equity has outperformed Premier Structured Mid-Cap A by 3 percentage points. And that's even without factoring in the effect of the load! But why shouldn't it outperform? Strategic Equity's expense ratio is also a full percentage point less.
Zimmerman's rules
To recap, here's what you should remember about mutual funds:
1. For every load fund, there exists a similar no-load fund that can be purchased more cheaply.
2. Funds with loads, on average, will almost always underperform no-load funds when the load is taken into account.
Don't chance sales commissions, share classes, or higher expense ratios. Lower fees are always the way to go when you can get them.
Where did I learn these helpful hints? From Fool fund guru Shannon Zimmerman, of course. If you'd like some help finding great no-load funds with low expense ratios and superior managers, consider being our guest at Champion Funds free for 30 days. You'll have access to specific fund recommendations, all the information you need to choose your own funds, and discussion boards where you can get answers to your questions in real time. Click here to learn more.
Intuitive Surgical is a Motley Fool Rule Breakers pick. Several of Vanguard's funds have been recommended in Champion Funds.
Ryan Angell owns shares of Vanguard Strategic Equity Fund. The Fool's disclosure policy is FDA-approved.*
*Always consult a physician before undertaking regular use.
