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Mutual Fund Sales Loads: Just Say No

Written by Nickel - 18 Comments

In my opinion, mutual fund sales charges are one of the biggest ripoffs in the investing world. Why should you pay upwards of 5% to buy something that you can essentially get for free from a no-load mutual fund family? You’re putting yourself in a relatively deep hole from the start, and your early returns will be eaten up just trying to get back to even money. So…

Imagine my surprise when I ran across a list of the twenty largest stock mutual funds in the most recent issue of Kiplinger’s and learned that twelve of them have sales charges ranging from 4.25% to 5.75% (avg = 5.625%). In truth, those numbers aren’t quite as bad as they seem, as ten of these funds, all of which have a 5.75% sales load, come from American Funds.

This begs the question… How is it that such expensive funds have managed to get so big? While I don’t know the answer, I’d be willing to bet that they’ve gotten their foot in the door on a substantial number of 401(k) plans, and people are buying them either because they don’t know any better, or because they don’t have a choice. Commissioned-based brokers/planners are another likely culprit — the higher the fees, the larger the commissions (thanks for pointing that out, Russ!).

A bit of investing advice

When investing, do everything within your power to minimize expenses. Stick to fee-based advisors, use no-load mutual funds, pay attention to the expense ratios, watch out for 12b-1 fees, and also be cognizant of taxes. These things can (and do!) add up over time, and will eat away at your returns.

Published on October 21st, 2008
Modified on September 24th, 2010 - 18 Comments
Filed under: Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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18 Responses to “Mutual Fund Sales Loads: Just Say No”

  1. 1
    Russ Says:

    The reason many of these heavily “loaded” funds have gotten so big is because they are not sought out by investors, but instead they are sold to uninformed customers by commissioned brokers who get the lion’s share of that up-front load for selling a fund to a client.

    Typically, if these funds are in a 401k plan, they use the same fund but a different share class to handle the fund’s compensation in a different, less transparent manner.

    Costs count big time, and it’s a shame that brokers can still sell these funds to clients.

  2. 2
    nickel Says:

    Russ: I suspect that you’re right. That fatter the sales load, the fatter the commission for the broker/planner. This is yet another reason to opt for a fee-only planner when seeking investment advice.

  3. 3
    Russ Says:

    That’s one of a long list of reasons I left Merrill Lynch a couple of years ago to become a fee-only, fiduciary advisor :)

  4. 4
    Tyler @ Dividendmoney Says:

    Russ,
    I’d like to comment you on your move.
    As an employee of a financial institution, we are always pushed toward sales goals – luckily my VP really does believe in doing what is best for the client, even if it means we make less money in the short term.

    Client’s are not stupid (at least not for long) and they will be loyal if you show them respect and provide only the best solutions that they require.

  5. 5
    Russ Says:

    Tyler,
    I applaud you and your commitment to the client. In the end, that’s what counts. I was very client focused while at Merrill and actually had a good overall experience and was not ever pressured to do anything that could compromise a client. And I am well aware of many people at the largest Wall St. firms that are good people and look out for their clients.

    Unfortunately, I also believe in guilt by association, and while people like you and me do what’s right, I got tired of apologizing for my co-workers and company when someone else did something wrong. There are several examples of this — current credit crisis to a rogue broker taking advantage of a client.

    Now, I don’t have to worry about that any longer, and neither do my clients. I’m a fiduciary and am legally required to put a client’s interest before mine so there’s not a question of whose interests are being served.

    Sorry for the rant, and I respect you for doing the right thing within a culture that doesn’t always embrace that. I wish you the best.

    @nickel – sorry for hijacking your post

  6. 6
    No Debt Plan Says:

    Someone left a comment on an article I wrote today about the same thing: http://www.nodebtplan.net/2008.....e-classes/

    Great minds think alike?

    Loaded funds are ridiculous. Simply baffles me.

  7. 7
    Geoff Says:

    Your lack of insight shows just how junior your financial knowledge is:

    “In my opinion, mutual fund sales charges are one of the biggest ripoffs in the investing world. Why should you pay upwards of 5% to buy something that you can essentially get for free from a no-load mutual fund family?”

    /A, /B, /C, and (to a lesser extend) /Z funds are managed differently than no-load funds. For instance, in a no-load fund, a fund manager may buy 100,000 shares of GM, believing that despite the current economic crisis impacting the stock value over the next 6-12 months, in 5 years the stock will be up by 25%. But in a fund with a front or back-end sales load, they may also sell GM short this quarter, invest in GM options, or do other things to hedge their positions during the next 6-12 months.

    The SEC has calculators for this sort of thing at http://www.sec.gov. If you are investing for 5, would you rather invest in a fund that is no load and earns 7%, or a fund that has a 5.75% front-end sales charge but earns 9%? With a 1% annual management fee, the no load fund will net you $3338 and the /A fund will net you $3790. So by paying the 5.75% up front, you would MAKE $452. If your time horizon is 10 or 15 years, or if the rate of return is greater than 9%, paying the sales load may not be a bad investment after all.

    Now obviously if you want to get out in 2 years, or if the rate of return is very similar, a fund with a sales load is NOT a good investment. But the blanket statement that a”sales charges are the biggest rip-offa” just shows how little you really understands.

  8. 8
    Dylan Says:

    Many loaded mutual funds are also available in a no-load and/or no 12b1 version of the same fund. Fidelity Funds and Fidelity Advisor Funds are a perfect example of this. Same investments, same strategy, same management, only the expenses are such that the broker sold “Advisor” versions charge a load and collect more in order to pay out ongoing commissions.

    American funds even has a no load share class. Also sometimes mutual fund companies will have no-load versions with entirely different names, like with Davis Funds/Selected Funds. People are generally not aware these alternatives exist because they are not typically available on a commissioned broker’s platform.

    Loads and distribution expenses have become the equivalent of an optional tax. There are more than enough, no-load choices available. Why pay more?

    Lastly, I think some financial publications must tread lightly and be careful not to alienate some of their advertisers.

  9. 9
    No Debt Plan Says:

    @Geoff: Show me how you can guarantee an increase in returns and I’ll gladly fork over extra money for expenses.

    If you compare the funds to their benchmarks or cheaper alternatives, over a long period of time, you will find they are all average. Law of Statistics.

  10. 10
    Dylan Says:

    @ Geoff – Spoken like a true career brokerage rep.

    There is absolutely ZERO truth to your claim that loaded funds are managed differently than no-load funds, resulting in a higher return.

    The sales load is strictly compensation for distribution.

  11. 11
    Geoff Says:

    I won’t get in a pissing match as to whether you should invest in funds with sales loads. Personally I like the flexibility of being able to get the hell out of one if I want, so I buy no load funds myself. I’m not saying everyone should invest in them – I’m simply saying the blanket statement that all sales loaded funds are evil is simply untrue.

    If you want *proof* that many (certainly not all) funds with a sales load perform better, just go to etrade.com (or whatever your favorite site is) and compare the same funds in no-load, /A, /B, and /C variants. I’m not making the blanket statement that all loaded funds manage their assets differently, but certainly some do.

    And no, I don’t guarantee an increase in returns. Nobody does. You’d be an idiot if you assumed that someone can. With greater returns comes greater risk. Past performance doesn’t guarantee future results. Blah blah blah. But there are more financial strategies out there than just “buy and hold”, and those in finance frequently implement them. If a fund manager is really good a picking stocks (winners and losers), market-neutral portfolios are far better investing techniques than going long on every bet.

    Again, I’m simply saying the blanket statement that all sales loaded funds are evil is simply untrue and demonstrates a lack of financial knowledge.

  12. 12
    nickel Says:

    Attack me all you want, but I’d like to see proof that loaded funds outperform no load funds. And don’t bother comparing, say, an international loaded fund with a no-load domestic. This is really analogous to the actively managed vs. index fund argument. You (or someone else) might argue that people get more for their money with an active fund manager, but that’s far from a general rule. Yes, some managers outperform in some years but, by and large, that simply not the case. Moreover, to profit from this strategy, you’d have to identify those funds/managers in advance.

    As to the strawman you constructed, of course I’d prefer to pay a load if I were going to receive a return that more than offset the additional cost. Anyone would. Can you provide me with clear evidence that opting for a loaded fund results in that sort of outperformance vs. no-load funds?

  13. 13
    Shadox Says:

    There is only one thing to say about the fact that people are still buying load funds: “there is a sucker born every minute!”

    There is absolutely no truth to the claim that load funds are managed differently – the only difference is that you get charged for the honor of buying their shares. Seriously, where do you get your information Geoff?

  14. 14
    g Says:

    If you screen any asset class of mutual funds, it seems that the best performing funds (over even the longest time frames) are generally no-load; or at the very least, there are some no-loads in the top tier.

    Why would anyone ever pay a load? Conspicuous consumption? Or just stupid?

    ETFs are also encroaching on all mutual funds, with lower expense ratios and they can even be acquired commission-free (zecco).

  15. 15
    stockmanmarc Says:

    5cNickel,

    Overall I agree with what you say about no-loads vs. loaded funds, but better yet I think indexing does better over time. Expense ratio’s very very low.

  16. 16
    Cheaplee Says:

    Unless a mutual fund can outperform a comparable index after fees, never buy a mutual fund. ETFs are just as sound, well diversified, and are extremely low in fees. Plus you can get in and out just like a stock, instead of waiting for the end of the day. You can also use a stop program to help mitigate losses. They come in every flavor imaginable since ETFs mirror an index (which comes in dozens of categories). There is simply no comparison.

  17. 17
    Nick Says:

    Returns are hard enough to come by, and when you fork over that extra percentage you’re just asking for smaller returns, regardless of the management type.

  18. 18
    Mick Says:

    I have spent the vast majority of my career undoing what “fee-based” advisors have done. Typically I am seeing a .75% – 1.5% management fee and then the no load mutual fund expense of .19% to .70%. So these fee based advisors are providing accounts that cost 1-2.25% All in. I can do the exact same thing with loaded funds A or C class and get them lower costs across the board. I transfer assets in a few times a month for this exact reason. Last one I did used No Load funds with some having Expenses as high as 2.2% for a commodity focused fund. The lowest expense he had was .76% and was paying the Advisor 1% for managing the money. THAT is the ripoff. Sure there are unscrupulous brokers who will push the highest commissions but just because someone is commission based doesn’t mean that’s what they are focused on. There are also unscrupulous advisors who charge fees and do no real work for the client. Sometimes I bump into those advisors at conventions and they are always talking about how much “FEE INCOME” they have every Jan 1. One in particular talks each time about how he has $150 Million under management at an average 1% so he has $1.5 Million in guaranteed fees when the year starts. You dont think that is a ripoff??? Do what is right for the client and everyone wins. It doesn’t do me any good to do the wrong thing for my clients only to see them unhappy in a year and leaving my firm. The more I do for them and the better they perform, the better my business is. Your statement is a gross generalization and unintelligent.

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