Many investors rely on mutual funds to build a diversified portfolio with small amounts of investment capital. Load funds, however, divert some of your hard-earned money and put it in the pocket of whoever sells the fund to you. Load funds impose sales charges, which are also known as sales loads, either on the front end when you buy fund shares or on the back end when you sell them. Those loads go directly to the broker or financial institution making the sale of the fund shares, and they mean that only a portion of your money will actually go toward your investment. Because so many no-load funds exist that don't charge sales loads, it's increasingly difficult to justify buying a load fund. In particular, with load funds charging as much as $85 for every $1,000 you invest, the draconian nature of load funds make them less attractive.
The history of load funds
To understand how load funds came to exist, it's helpful to look back at their history. Before the 1970s, brokerage companies were regulated in such a way that extremely high commissions prevailed across the industry. Investors became used to the idea of having to pay hundreds of dollars in commissions just to do a simple stock trade that today would cost less than $10 to execute. As a result, the idea of paying a similar commission in the form of a sales load to buy a load fund didn't look quite as out of line as it does today. Indeed, given the incentives to sell stocks, mutual funds almost had to impose loads just to persuade advisors to consider fund shares as an option rather than individual stocks.
With deregulation in the brokerage industry, commissions on stock trades plunged. In addition, the advent of index mutual funds, many of which charged no sales load, made no-load funds readily available to ordinary investors. As the performance record of no-load funds grew, investors saw that there often wasn't any marked difference between the two types of mutual funds. In fact, because no-load funds had lower fees to overcome, they were often able to outperform their load-fund counterparts.
How load funds work -- and why you don't need them
The two main types of load funds involve front-end or back-end loads. For front-end loads, a percentage of your investment is taken as the sales load. That percentage typically drops as the size of your investment grows. For instance, fund giant American Funds has some load funds with a maximum 5.75% sales load for those who invest less than $25,000 in the funds. However, when you hit $25,000, that load amount falls to 5%. Further declines occur until you hit $1 million, at which no load is imposed at all.
Similar rules apply to back-end loads, although they typically take a different form. For back-end loads, the percentage is highest for someone who sells shortly after purchasing the fund shares. Over time, the load falls. Eventually, you won't have to pay a load at all if you hold onto your shares long enough.
Even though there are ways to reduce the charges that load funds impose, it's far easier to choose a no-load fund. Although a few load funds have put together impressive track records of performance, the many load funds struggle to overcome the downward pressure on returns that their sales loads inflict. By keeping total fees in mind, you can make a smarter choice that avoids seeing a portion of your initial investment go into the pocket of your broker rather than into the investments you want to buy.
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