No-Load Mutual Funds
vs
Load Mutual Funds

There has always been controversy over the issue of no-load mutual funds vs load mutual funds. You will often hear that for virtually every load mutual fund there is a no-load mutual fund that is equal in every way, or even better than, the corresponding load funds. However, commodity mutual funds are a notable exception to that statement, otherwise it's pretty accurate.

According to the Investment Company Institute, there were 8889 stock and bond mutual funds domiciled in the U.S. as of December 2008, approximately 20% of them were no-load mutual funds. These +/-1800 funds cover all the major asset classes, investing styles and developed or developing regions of the world. Among these, you will find high-performers in every category.

Most persons who sell load mutual funds are sales professionals and may have a limited knowledge of investing, as they were trained to sell rather than to invest. Some have an extensive knowledge of investing, others do not. So, although their sales pitch is that they are providing you with "free" investing advice, they may not be well-qualified to render such advice. If your purchase is substantial, then you may pay dearly for this "free" advice, especially if the quality of the advice leaves a bit to be desired.

If you consider buying load mutual funds, you need to assess the value of the advice and compare it to the amount of the load. If the salesperson doesn't have the credentials of a true investment professional, then the advice may have limited value or may even have negative value. If you need advice, you should consider paying for it directly and using it to select no-load mutual funds that meet your needs. In either case, you should carefully evaluate the credentials of the person rendering the advice. If the value of the services you are receiving in return for the load is not commensurate with the amount of the load, then there is no good reason to pay the load.

A load is a sales commission and usually runs about 5% of the amount you pay for shares of a load mutual fund. Most load funds are front-end loaded, back-end load funds are addressed below. With a front-end load of 5%, only 95% of the money you pay is actually invested, so you automatically suffer a 5% loss right out of the starting gate. And, as only 95% of your money is invested, the load is actually 5.26% of your investment, rather than the 5% that is stated. It takes truly stellar performance to overcome the effect of a 5% load.

Another drawback of load funds is that the commissions provide an incentive for salespersons to sell you more of their "product." This can happen in two ways and to varying degrees. First, the salesperson may attempt to sell you more mutual fund shares than is appropriate for you. They may very well feel that you know how much of your wealth should be invested in the various asset classes and that you will decline the offer if you feel it is inappropriate, or they may do it with a total disregard for your financial needs. Second, and much worse, the salesperson can generate more commissions by churning your account. Churning is an unethical practice that involves the trading of securities for the sole purpose of generating commissions. In other words, whoever sells you a load fund has an incentive to recommend that you sell that fund and buy another load fund so that they can "earn" another commission. This unethical practice occurs to varying degrees and investors need to be aware that the opportunity exists for the ethically challenged to exploit. Not all persons or companies that sell load funds engage in churning. The integrity of these persons and firms spans the spectrum from those who sincerely want to do a good job for you to those who are out to make a quick buck at your expense. If you purchase no-load mutual funds rather than load funds, this potential conflict of interest is eliminated.

On the far end of the spectrum from highly rated no-load mutual funds are the funds managed by the major brokerages. As a group, these mutual funds have sub par performance records. Plus, if you buy a major brokerage's "house" funds, you will not only pay a load, you will also pay commissions when you buy and again when you sell.

The people and firms that sell load funds almost always are restricted, at least to some degree, in the selection of funds they can sell you. There are two problems with this: 1.) The selection they have to offer may not be capable of providing you with an adequate degree of diversification. 2.) The selection probably is not comprised of the stellar performers you need to overcome the load. For these reasons, even those whose intentions are good, usually are not in a position to provide you access to the diversity of high performing mutual funds you need.

The foregoing applies to full load funds and to a lesser degree to low load funds. So now I'll address low load mutual funds.

In recent years, many no load mutual funds have become low load mutual funds, which are funds that charge a load of 3% or less. As with full load funds, the load can be front-end or back-end and the effect of the load must be factored into fund performance.

Why did these funds decide to add a load and lose their no-load status? Well, supposedly they decided they needed the money for marketing so that they could compete with the load funds for customers, and that may be true to varying degrees. As you've probably figured out by now, marketing usually consists mainly of paying commissions to someone for selling mutual funds. Personally, I think part of their reasoning was driven by the desire to enhance their earnings, which is definitely the case with fund shares purchased directly from the fund companies when a load is charged.

Some mutual funds are back-end loaded or have deferred sales charges, which are one in the same. With these funds, the load is deducted at the time of redemption. Some back-end loads are charged on the lesser of your initial investment or the final value of your investment. And, just to make things a little harder to evaluate, some back-end loads are classified as contingent deferred sales loads (CDSLs). The rate of CDSLs diminishes with time and eventually goes away, i.e., becomes 0%, usually after a holding period of five to ten years. So to evaluate your performance or probable performance, you need to know what your holding period is going to be. Read the prospectus carefully and do the math!

One other thing to consider when venturing beyond the realm of no-load mutual funds is the 12b-1 fee. No-load mutual funds are restricted to a maximum of 0.25% per year, although many do not assess a 12b-1 fee, but load funds can charge as much as 1%, which reduces your return by the amount of the fee. So, if a fund with a 1% management fee and a 1% 12b-1 fee returns 12%, your return net of fees will be 10%. With a no load mutual fund with no 12b-1 fee and a management fee of 1% that returned 12%, your return net of fees would be 11%. That extra 1% compounded over a number of years becomes a whole lot more than 1%, as you'll learn later on this site.

Special considerations in computing the returns of load mutual funds can be found in the subsection on Mutual Fund Returns.

Should you consider low load mutual funds? That's entirely up to you. As far as I'm concerned, they're load funds and have all the drawbacks of full load funds but the effect of the load is less. However, I'd be remiss in advising you to write them off without comparing them to no-load funds after adjusting for risk and fees, as some of these funds have demonstrated very good long-term performance as no-load funds. The question is "Can they now perform well enough to overcome the effect of the load?" There are probably some that can, and it's more likely than with fully loaded funds.

Adding a load of any kind impairs those funds' performance relative to no-load funds. Astute investors like you, who do enough research to know what they're buying, will select funds with the best performance after adjusting for risk and fees, which will usually be no-load mutual funds.

The two important facts that you need to remember regarding the issue of no-load mutual funds vs load mutual funds: 1.) With the exception of commodities funds, for virtually every load mutual fund there is a no load mutual fund that is equal in every way, or even better than, the corresponding load funds. 2.) As a group, load funds underperform no-load funds in the same categories when the load is factored into the performance calculations.

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Return to the introduction to mutual fund investing.

Move on to the next subsection, Mutual Funds vs Stocks & Bonds.