There are few "gimmes" in investing. But today, I have advice that will both save and make you money.
First, some background
Half of all American households own equities, according to data from the Investment Company Institute (ICI). Ninety percent of those equity owners invest in stock mutual funds (only about 50% own individual stocks).
If you or anyone you know is included in this group, listen up: You're probably paying too much to invest.
Just say no
How so? Most mutual funds sold through advisors are "load" funds, and according to the ICI, "Professional financial advisors are the main conduit to equity ownership outside employer plans."
A load fund has a sales charge levied by an intermediary -- a broker, financial planner, or advisor. In theory, the sales load reimburses the intermediary for advice and expertise.
So here's what we know: Huge numbers of Americans own funds; the "main conduit" to buy them outside an employer plan is through advisors; advisors charge sales loads ...
... and sales loads all but guarantee poor performance.
Most obviously, the load takes a slice of your assets off the top (or the bottom, in a back-end sales load). Consider the John Hancock Growth Trends (JGTAX):
5-year returns vs. S&P 500
(3.4) percentage points
The math is straightforward: If you were to invest $5,000 in this fund, your actual stake would be just $4,750 ($5,000 minus 5%). (Seems harsh, given all the no-load choices that also have major stakes in Dell, Hewlett-Packard, and Schering-Plough.)
This information would've been useful -- yesterday
If you're already invested in a load fund and have absorbed the 5% ding, don't tune out. It's about to get a whole lot worse.
It turns out that load funds consistently underperform no-load funds, even when backing out fees.
That's what Tim Hanson and I found in our survey of the best funds of the past decade. (76% of the top-performing funds were no-load funds.)
Academic research drives the point home even more: In 1998, Professor Craig Israelsen found that "even after ignoring the impact of loads, no-load funds had, on average, significantly higher returns."
Five years later, in a Financial Planning Magazine article, Israelsen studied a different time frame. The result was the same, however: No-load funds were superior to load funds.
A pattern is developing
Israelsen also shattered the rationale given by load-fund shops for the load funds they sell:
The party line being that -- over time -- a lower expense ratio partly, or perhaps fully, offsets the impact of a front or deferred load. [But] no-load funds ... had expense ratios which, on average, were about 37 basis points lower than the average load fund. ... Thus, the lower cost structure of no-load funds was only partly responsible for their superior performance.
So load mutual funds not only cost you more in fees, they cost you more in lost returns!
There's only one conclusion: Don't touch them with a 10-foot pole.
More to the story
As you go about the business of investing, avoiding loads will get you a long way.
You'll also want to follow the advice of the fund experts at Motley Fool Champion Funds, who look for tenured managers, consistency of style, and low expenses. If you want a shortcut to get going, consider taking a free trial of Champion Funds. You can sample the service for an entire month, see all past picks, and read every back issue without forking over a dime.
If you decide to join after your trial, it certainly won't cost you as much as a load fund. To learn more about the free trial offer, click here.
This article was first published Nov. 8, 2007. It has been updated.
Brian Richards does not own shares of any company mentioned in this article. Dell is a Motley Fool Stock Advisor and Motley Fool Inside Value selection. The Motley Fool's disclosure policy enjoys rich chocolaty Ovaltine.