Load Funds Vs No Load Funds
Load (for Mutual funds) can be defined as a fee or a commission that an investor has to pay to the mutual fund company at the time of buying or redeeming the shares of the mutual fund.
If the fee is charged at the time the investor buys the shares, it is known as the front-end load. If the fee is charged at the time of redemption of the shares by the investor, it is known as the back-end load.
Sometimes back end load applies only when the shares are sold within a specific time period after being bought.
The reason given by load funds to impose loads on mutual funds transactions is that loads will discourage investors from frequent trading in mutual funds. If investors move in and out of mutual funds quickly then the funds have to maintain a high cash ratio and this may lower the returns of the funds. Also more trading will mean funds have to pay more commissions to their brokers and this will decrease returns.
All the fees received as load fees goes in paying commission to the fund brokers. It does not provide any incentive for the fund manager for better performance of the fund. Thus a load fund has no reason why the fund managers should perform better than those of the no-load funds.
In the past few decades no difference has been seen in the performance of no-load and load funds (not considering the load). When the load is considered, the investors who paid a load in load funds lowered their returns.
Also load funds encourage sales persons to push their funds and thus lead to partial marketing of funds where the sales persons push load funds over no-load funds, even when the load funds are performing poorly compared to no-load funds.
If you already own a load fund, do not sell it just because now you feel load funds are bad. You have already paid the load (in both cases of front-end and back-end loads) by buying the fund and thus you hold or sell decision should be based on how well you think the fund will perform in the future. In certain funds, longer you hold the fund; lower your back-end load. Check the details in the fund prospectus.
Loads are actually understated for investors. For an investment of $1000 in 5% load fund, the actual load ($50) is on $950 (the investment that reaches the fund after load is deducted). $50 is actually 5.26% of $950 and thus the effective load is 5.26% for the investor.
Another important point is that just because a fund is a load fund doesn’t mean you should avoid it. Here is an example to explain the point. A person decides to invest 1000$ in a fund which has two classes – Class A and Class B. Class A has 3% front-end load and Class B has no load. The person missed the fine print, which stated the Class B had 1% 12b-1 annual fees.
If the fund made 10% gains each year Class A fund will be
$970 *1.10*1.10*1.10*1.10*1.10 = $1562.
For class B the initial amount is $ 1000, but there is a 1% annual reduction due to 12b-1 fees.
$1000 * (1.10*0.99) * (1.10*0.99) * (1.10*0.99) * (1.10*0.99) * (1.10*0.99) = $1532.
Thus you can see from the above example that Class A fund gives a better return in spite of being a load fund because of the 1% 12b-1 fees applicable to Class B fund.
A fund cannot be considered a true no-load fund if it deducts 12b-1 fees from assets of the investors.