04/05/99

Load and No-Load Mutual Funds

In last month’s article I explained numerous ways to evaluate and select mutual funds. To keep the article from being too exhaustive, I did not discuss load and no-load funds. In this article I will explain the differing types of load funds, ways to reduce load charges break-points & rights of accumulation), review other fund expenses, and comment on the advantages of both load and no-load funds.

What is a Load/No-load Fund?

A fund with a load has a fee that the investor pays. A fund may have a "front-end" load or a "back-end" load, rarely , if ever, both. A front load is a fee on new money invested. The load is expressed as a percentage. A front-end load is commonly 5.75% for equity funds, less for bond funds, and is simply deducted from the amount being invested. A back-end load is a declining fee on the amount of principle withdrawn from your account. Typical back-end load fees range from highs of 3% to 7%. Back-end loads are declining, so that after a certain number of years (usually 4 to 8 years depending on the fund) there is no charge for withdrawing your original principle. For example, if you withdrew principle the first year there would be a 7% load, 2nd year - 6%, 3rd year - 5%, etc. Eventually, the back-end load declines to zero.

The load is charged to the investor, in part, to compensate the financial advisor/broker for his or her advice and on-going oversight of the investments.

A true no-load fund has neither a front-end or a back-end load. The funds are considered "self-service" funds. Since you select and monitor the investments yourself, there is no broker or advisor to compensate with the load.

Share Types and Corresponding Loads

The type of load an investor pays corresponds to the mutual fund share type one is purchasing. The most common share types are A, B & C shares. For example, A shares have a front load, B shares have a back-end load declining over a range of years and C shares have a one year 1% back-end fee. These share types are the most common for individual investors. If you have a company 401k plan you may have noticed other share types such as M or Y shares -- these shares do not have loads and are only offered to group plans or investors with large assets. You may even have A or B shares in your 401k or other retirement plan, but chances are the loads have been waived.

Why the different types of loads?

Mutual fund companies created the varying load types to accommodate the individual investor. Investors, with differing goals and personal preferences, can have the option of choosing how they want to pay. Which one is right for you depends on your goals for the money invested and the actual charges you may face depending on which company/fund you are investing in.

Reducing and Avoiding Loads

Front loads can be reduced if you are investing or planning to invest a certain amount of money. The load reduction schedules are called "break-points". For example, with most fund companies if you are investing over $100,000 or plan to within the next 13 months, you will get a 1% reduction on the front load. The more you invest, the greater the reduction in the load. For some fund companies the break-point reduction begins at $50,000 over 13 months, and with many funds, if you invest over $2 million there is no front load.

If you do not have $50,000 or $100,000 to invest over the next 13 months, you can still earn a reduction on the front load, through "rights of accumulation". Under accumulation rules you will receive fee reductions on the front load when your total investments with one fund family have grown past the break points. Therefore, if you only have $20,000 to invest today, that’s OK, someday soon it will grow past the $50,000 or $100,000 initial break-point and you will be eligible for the load discount on your further investments.

It is perhaps a little known fact, but with most fund companies you can withdraw money from a B-share and avoid the back-end load before it declines to zero. With many B shares, you can withdraw a certain percentage -- from 8% up to 24% depending on the fund -- of your principle in the early years and avoid the back-end sales charge. In most cases, the stipulation is that you must withdraw your principle out over a period of time through automatic withdrawals to avoid the back-end load. The growth in your accounts is not subject to the back-end load.

Other Fees in load and no-load funds

Whether you are investing in loaded or no-load funds you are still paying management and, in some cases, 12b-1 fees. The management fee is compensation for the fund manager - the person who is responsible for buying and selling the stocks and/or bonds in the funds portfolio. A 12b-1 fee is a sales and marketing fee. With respect to loaded funds, the 12b-1 fee is generally higher in B and C shares than in A shares. B-shares often convert over to A shares after a certain number of years and this higher 12-b1 fee is eliminated.

The Advantages of Loads and No-loads

The advantages of each is simple. With no-load funds, you do not have to pay either a front-end or a potential back-end load. Avoiding these fees leaves more money to accumulate in your account. On the other-hand, no-load means no help -- there is no financial advisor or broker to advise you on fund selection and to monitor your investments over time. If you are a conscientious investor -- understand investments, regularly review your accounts, pay attention to shifts in market & economic conditions, do not procrastinate on making changes, and generally do not buy or sell at in-opportune times, than you do not need assistance from an advisor or broker. If you fit this profile, no-load funds are a smart choice.

Alternatively, the advice received from an advisor or broker on fund selection, oversight and future buying/selling or re-balancing could earn you more money over time and more than compensate you for the loads paid.

Please send questions or comments to dcoffin46333@wradvisors.com.