I admit it. I'm biased. Whenever someone tells me that they bought a mutual fund through an investment advisor, I wince.

Sure, some advisor-sold funds perform well. For instance, several international funds from BlackRock (NYSE:BLK) generated good returns compared to their benchmarks during the past bull market, as did a number of other funds available only through investment advisors.

But I wince because those returns usually come at a steep price. And I have a hard time believing that people are getting value for that price, especially in a world where it's so easy to research and buy no-load funds online.

According to the Investment Company Institute, the mutual fund industry's trade group, more than 80% of investors who own mutual fund shares outside of a workplace retirement plan bought at least some of those shares through an investment advisor. And whether they realize it or not, those investors paid -- and in most cases, are continuing to pay -- quite a bit for that privilege.

How your advisor gets paid
Typically, when an investment advisor who works on commission sells a fund, he or she gets two types of payments: a large up-front commission as a reward for the sale, and an ongoing stream of payments (called a "trail commission") that provides an incentive for the advisor to keep those assets in the fund. The money to pay these commissions, in turn, comes from two sources: the fund's load, and its 12b-1 fee. The latter is named after a provision in the Investment Company Act of 1940 that allows fund families to charge shareholders for (cough) "distribution expenses," on the dubious theory that larger funds' economies of scale are better for shareholders.

The way in which these charges are structured depends on which class of shares you're being offered. In general, advisor-sold funds typically have several classes of shares. Each class has a different fee arrangement, but the shares are all invested in the same mutual fund, have the same managers, and pay the same underlying management fees.

The details
For instance, suppose you're interested in Fidelity Advisor Aggressive Growth Fund. The Fidelity Advisor fund family is sold only through (surprise!) investment advisors, so you'll need an advisor's help to make your investment. You'll probably be offered one of these classes of shares:

  • Class A: A high front-end load (you pay when you invest) that pays for the upfront commission and a relatively low annual 12b-1 fee. On this fund, the load is a whopping 5.75% (though there's a discount if you're investing more than $50,000), and the 12b-1 fee is 0.25% annually.
  • Class B: No front-end load, a high contingent deferred sales charge (CDSC, also sometimes called a back-end load), and a high 12b-1 fee that is reduced after a set period of time. The CDSC, which is paid when you sell your shares, is called "contingent" because it declines over time. The advisor's up-front commission is advanced by the fund company, and paid back by you via that big 12b-1 fee. The CDSC ensures that the fund company can recover its commission if you decide to sell before paying it off via the 12b-1. Here, the CDSC is 5%, declining gradually to zero over six years, and the 12b-1 is a full 1% -- but after six years, your holdings will be converted to Class A shares, and your 12b-1 fee reduced accordingly.
  • Class C: no front-end load, a low CDSC that goes away after a short period of time (typically a year), and a big 12b-1 that never gets reduced. On this fund, the CDSC is 1%, it goes away after a year, and the 12b-1 is also 1% with no future reduction -- essentially, the upfront commission is being financed over a longer period.

I've used the Fidelity fund as an example, but these structures (and naming conventions) are standard across the industry, with small variations in fee levels between fund families. If you really want a particular advisor-sold fund, be sure to ask about the fees on all the classes available.

Is it ever worth it?
It's a no-brainer: Taking a 5% bite out of your up-front investment, or a 1% annual bite out of your annual returns, can have a dramatically negative effect on your long-term investment results. Given how simple it is to discover a fund's top holdings, you can just as easily buy individual companies yourself. For instance, if you like the Fidelity Advisor fund discussed above, you could just buy shares of the companies it contains, such as Costco (NASDAQ:COST), Burger King (NYSE:BKC), Cephalon (NASDAQ:CEPH), and Morgan Stanley (NYSE:MS).

Furthermore, in an era when anyone can get market-level performance with a few minutes' effort by buying an index fund from somewhere like Vanguard or T. Rowe Price (NASDAQ:TROW), advisor-sold funds are harder to justify than ever. If an advisor's recommendations for long-term holdings aren't beating the S&P 500 net of all fees on an ongoing basis, then you're probably better off looking elsewhere. Too often, you'll find yourself owning the same shares of blue-chip stocks, such as ExxonMobil (NYSE:XOM), as an index fund -- but paying much higher fees.  

And of course, if you decide you want to find market-beating no-load mutual funds on your own, you've come to the right place. Consider taking our excellent Motley Fool Champion Funds service for a free 30-day test drive. It's one of the best ways out there to get focused on the highest-performing funds available, quickly and painlessly.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.