Why No-load Mutual Funds

by Paul Merriman

It's not true that no-load funds are inherently superior to load funds. That's too simple. A sales load - or the lack of a load - is not the most important thing about a mutual fund. Obviously you're better off in a great load fund than an awful no-load fund. But those are not your real choices. I simply don't see any reason why a well-informed, intelligent investor should pay a sales commission to invest in a mutual fund. Certainly any investor who is capable of finding the way to this Web site and reading this article is able to recognize and find good funds without paying for that service from a broker whose interests are almost inevitably in conflict with the interests of the investor.

But I'm getting ahead of myself. I'd rather tell you the facts and let you draw your own conclusion.

"Load" is simply an industry term for a commission that a mutual fund pays somebody for "selling" the fund by bringing in investors. Some funds pay such commissions. They are called load funds. Other funds don't. They are called no-load funds. Some funds charge loads when investors redeem shares, and many funds have loads that include annual fees to cover their marketing expenses.

A load goes to the fund's sales force, not its portfolio managers. Portfolio managers make their money from fees taken from the fund's pooled assets, in effect charging every investor a share of management costs. The fees are typically 0.5 percent to 1.5 percent of the fund's assets annually - although some fees are considerably lower and some are considerably higher than that range.

The presence or absence of a load does not affect how well the fund's investments perform. But a load has a big impact on you as an investor because it reduces the amount of your money the fund manager has to work with. To see the difference, imagine one day you invest $10,000 in a no-load fund and another $10,000 in a fund that charges a 4.5 percent load. In the load fund, your broker or planner will fill out the paperwork, which is usually less difficult than opening a bank account. In the no-load fund, you will handle the paperwork yourself.

You may think you have invested $10,000 into the load fund, but the fund pays $450 of your $10,000 to the broker or planner. That means the fund's manager has only $9,550 of your money to invest on your behalf. That puts him at a severe disadvantage compared with the no-load fund manager, who starts with $10,000 of your money to work with.

Assume each fund manager is equally successful at investing your money, achieving a 10 percent gain in a year. At the end of one year, your account in the load fund would be worth $10,505 (110 percent of $9,550); your no-load account would be worth $11,000. The difference is $495, or 4.95 percent of your original investment. Notice that this difference is more than the $450 load you paid. By paying the load, you permanently and forever lose the income on the $450 that your fund paid to the sales agent.

That may not sound like a large amount. But in effect that $450 sales commission would require your load fund to appreciate by 15.2 percent in one year just to equal the 10 percent performance of your no-load fund.

In a horse race, very few people would stake their money, especially large amounts of it, on horses that were required to start far behind their competitors. There's no reason investors should put up with such a handicap either. In the end, your best mutual-fund buy will always be a no-load fund with a good performance record and with goals and strategies that match your own.

If you already own a load fund, there is not necessarily any benefit to replacing it with a no-load fund, and that decision should be made on the basis of other considerations.

To see a list of the largest load funds and our suggested no-load alternatives, visit fundadvice.com/explode.html

Paul Merriman, one of America's top financial advisors and asset managers, manages over $300 million using buy-and-hold and market timing strategies and is one of the nation's top experts on mutual fund investing.

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