The sales commission charged to buy and sell its shares
In short:
Mutual funds with loads are funds that charge a fee to purchase or sell their shares. This fee is paid by the investor and is calculated as a percentage of the investment. The fee can either be paid by the investor when they purchase shares called a front-load fund, when they decide to sell their shares called a back-load fund, or paid over time called a level-load fund. Not all mutual funds charge a load to purchase and sell their shares.
The load does not have anything to do with the annual management fee, called the expense ratio, investors pay the fund operator to manage the fund for them. That is, if a fund charges a load, it will be an additional expense for the investor on top of the annual management fee.
The maximum load fee a mutual fund can charge is 8.5% with the typical range somewhere between 3% to 6%. It is possible to buy a load fund and eliminate the load fee which we discuss more below.
Key Points
- Mutual fund loads are sales fees the fund charges to buy and sell its shares
- Not all mutual funds charge loads
- Front-loads are charged to the investor on the purchase
- Back-loads are charged on the sale
- Level-loads are charged over time
In-depth:
Mutual funds
A mutual fund is an investment vehicle which pools money together from many investors in order to implement an investment strategy which could include buying stocks, bonds, or other assets. Mutual funds give investors access to professional money managers who allocate the funds money on behalf of their investors, often giving investors access to better diversification (reduced risk) than they could have on their own.
Essentially, mutual funds allow investors to bet on a group of companies by buying into the fund instead of having to go out and buy all those companies individually. This, therefore, saves them time, money, and gives them access to a full-time professional.
Now, given the way the vast majority of traditional mutual funds are set up two key points are brought into the equation. Key point one, most mutual funds are actually just a special type of company whose business is investing. They can issue common shares just like Ford Motor Company can. The difference is that most mutual funds are “open-end” which simply means they can continuously issue more shares whereas Ford cannot easily issue more shares.
Key point two, since “open-end” mutual funds are set up this way to continuously issue more shares, investors must buy shares directly from the fund itself instead of on an exchange like the NYSE. Likewise, when an investor wants to sell their shares they must sell them directly back to the mutual fund.
You may have noticed most mutual funds only have one price per day, this is the reason. To issue new shares and be fair to the current investors, the net asset value per share is calculated once per day. Shares will then be bought or sold at this price for that day.
In order to get interest from investors, load funds charge a sales fee which goes to compensate the financial intermediary, such as a broker or financial planner, for taking the time to research, recommend, and sell the fund to an investor. Basically, this becomes an incentive for brokers to give coverage to the fund and put it in front of their clients as an option.
Types of loads
When an investor is looking at a mutual fund that charges a load, they may have a few different options to choose from which are listed below. Depending on the fund and their choice they may be able to reduce the load fee.
- Front-end load: This is where the investor will be charged a sales fee when they first purchase the shares. Typically, the shares that have this fee will also have a lower additional annual expense ratio.
- Back-end load: This may also be referred to as contingent deferred sales charge (CDSC). This sales fee will be assigned when the investor goes to sell their shares. The unique thing about back-end loaded funds is that the fee may be able to be eliminated by holding the shares long enough. For example, the fee may start at 6% if sold within the first year then move to 5% if sold during the second year and so on until the fee is gone.
- Level-load: This is where the fund doesn’t directly charge a sales fee but instead charges a smaller annual fee called a 12b-1 fee which goes to marketing the fund.
Types of shares
Mutual funds can issue multiple classes of shares which allows investors to decide how they want to pay the sales fee. There are pros and cons to each type of class that an investor must consider for themselves.
- Class A: Generally, these are front-loaded so the investor will pay the sales fee upfront when they purchase the shares. Typically the fee will be anywhere between 4% to 6% but will vary by fund.
- Class B: These shares are back-loaded where the sales fee will be assessed on the sale. These fees reduce the longer the shares are held typically being eliminated after 5 to 8 years.
- Class C: Level-load fees can be expected with class c. The investor will be charged an annual 12b-1 which could be somewhere between .5% and .75%.
Advantages of load funds
Why buy a mutual fund that has a load? Well, as the saying goes, you get what you pay for. The load the investor pays goes to paying the broker, financial planner, or financial advisor for the time they put in researching and investigating the fund. A good financial advisor could spend quite a bit of time looking into the money managers of the fund, their background, their experience, and their track record. To do so they may use resources and connections average individual investors do not have. If done right, the research could put your money in a better position to perform the way it’s intended.
The big key in this equation is finding the trusted financial advisor who does additional research on their own above and beyond what their back-office sends them.
Disadvantages of load funds
Why not buy a mutual fund that has a load? For the enterprising investor who has the desire, time, and skill, it is possible that they can do just as well without paying a load fee. This is because the access to research via online brokers and the availability of mutual funds reduces the advantage of paying someone else to do the work.
The key here is the experience, skill, and expectations of the investor who chooses to go this route.
Additionally, when an investor buys a font-end loaded mutual fund that charges 5%. If they invest $10,000 in the fund, instead of all $10,000 going to work for them only $9,500 is investment capital.