Mutual funds arguably are the most commonly known investment products in which consumers actively participate. While a large number of people are familiar with them only through their employer-sponsored retirement plan, such as a 401K or 403b, others hold mutual funds in an IRA or brokerage account. Despite the fact mutual funds are ubiquitous in the investment industry, many investors remain uncertain when it comes to fees and expenses.
The biggest disconnect between investors and the mutual fund industry stems from load funds and no-load funds. Load funds attach a sales charge either up front or on the back end when the fund is sold in order to invest, whereas no-load funds eschew a sales charge altogether. However, load funds also tend to have lower expense ratios that can eat away at your annual gains, whereas a no-load fund generally comes with a higher expense ratio.
The differences in annual expenses can be minimal, though. Many load funds have 12b-1 fees on par with the expense ratios in a no-load fund. The big question, though, is performance. It seems logical that a fund that charges a sales fee to invest would have a stronger management team and boast better returns, whereas a no-load fund might lag behind. The truth actually is the opposite.
How They Stack Up
There have been repeated studies on the performance of load mutual funds and no-load mutual funds, with the data cross-checked and compared numerous times to verify its accuracy. The results weren’t what you might think. Time and again, it’s been shown that no-load funds consistently outperform their load fund counterparts.
A study done in 2003 for the Financial Planning Journal revealed that during the time period between 2000 and 2002, no-load mutual funds outperformed load fund by a range of of 10 to 430 basis points – a considerable margin, especially considering investors were paying extra to be in mutual funds that charge a load fee.
The reason behind the consistent outperformance makes sense when you look at the numbers. Simply put, if two funds performed the same but one charged more than the other, investors who held the cheaper one ended up reaping the larger gain.
Load mutual funds offer what is known as share classes – typically labeled “A,” “B” or “C” shares. “A” shares is a share class that charges an up-front fee in order to invest in the fund. The average fee for a stock fund runs at around 5%, while bond funds average 3.5% – although they can go as high as 8% in some cases. The upside to investing in “A” shares is they come with the lowest internal expense ratio.
“B” shares are almost all phased out now, but some investors may still hold some of these mutual fund share types. They behave in the exact opposite manner of “A” shares in that “B” shares charge a “back end” fee when withdrawing money from the mutual fund.
The most common share class is the “C” share. This class has no up-front or back-end sales charge, but does have the highest expense ratio, often topping 1.5% annually. For long-term investors, that fee can eat away at returns, making it an inefficient share class compared to its peers.
Finally, there’s no-load funds, which don’t differentiate between share classes. All investors buy the same type of share in the mutual fund with no sales charge – although it will charge an expense ratio. In practice, most no-load funds carry relatively low expense ratios compared to their load peers, making the return difference over a long period of time even more considerable.
No-load mutual funds are becoming more popular with investors, and it’s easy to see why. Funds that charge a sales fee don’t have any evidence to suggest a stronger track record; in fact, there’s evidence that suggests the opposite. One benefit to load funds, though, is they typically are offered through a financial advisor, which means you get access to professional advice. For busy or inexperienced investors, simply knowing someone is watching over their money may be worth the extra cost involved.
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