Insights & Advice

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It’s No Load or No Thanks

Mutual funds that charge investors sales charges, called loads, should never be a part of your investment portfolio. And yet, in just about every portfolio I have reviewed in the last six months, that’s practically all I’ve seen. It is clear to me that investors who have retained the services of financial consultants, brokers and investment advisors are getting royally shafted when it comes to paying for their services (and they don’t even know it!).

“Well, he has to make a living, doesn’t he?” said one prospective client from North County who has been a long-time client of just such a manager.

“Sure, but there’s a difference between making a ‘living’ and highway robbery,” I said.

In my column “Mutual Fund Fees: Why should investors pay more than Institutions”, I revealed the unethical charges called 12b-1 fees. That’s the common practice among many advisors and brokers (including your own) of investing you in a mutual fund that will then kick back part of the expense each fund levees on shareholders. If, for example, The Unethical Investment Fund has a 1.00% fee, they will pay your advisor or planner a percentage of that as a commission for putting you into that particular fund and they will continue to do so for as long as you hold the fund. It is legal although it won’t show up in any of the statements they send to you every quarter. For many managers, we’re talking about a lot of extra fees each year that are coming out of your pocket; fees that are paid to the advisor, in addition to any management fee you are already paying them.

Above and beyond that backroom arrangement, sales charges are a common occurrence among financial services professionals. There are three main categories.

Front-end loaded funds require you to pay a fee when you purchase the fund. They are easily identified as “A” shares. If you put $1,000 into such a fund with a 5% front-end load, $50 will go into your broker’s or advisor’s pocket and $950 will be invested in the fund. Back-end loaded funds, or “B” shares, have deferred sales charges. If you sell a back-end load fund before a certain time frame, you pay a sales charge. For example, if you sell the fund in the first year you could pay a 5% charge, dropping to 4% in the second year, less in the third and finally ending in 5 to 7 years, when you won’t have to pay any charge at all.

The “C” share or level load fund is the final category. These funds won’t charge a front or back end load, but usually charge the highest annual expenses of the three share classes, including hefty 12b-1 fees (1.00% is the highest annual 12b-1 fee allowable by law). So if you own an A, B, or C share mutual fund, your broker has received a nice kickback, in addition to the annual management fee you may already be paying. What, you might ask, have you received in return?

Morningstar, the premier mutual fund rating service, did a survey of the performance of no-load funds versus load funds and found that no-load funds actually have a superior record to load funds over three and five years. That should make intuitive sense to most readers. Instead of paying your broker that 5%, you can buy that many more shares of the fund of your choice. These loads over as short a time period as three years can easily shave your returns by as much as 10%. On a $250,000 portfolio, that could mean $25,000.

But what is even more astounding to me is that no-load funds with equal, if not better performance, can easily be purchased either directly through a brokerage account or by simply instructing your broker, financial consultant or investment advisor to do so. Of course, most financial service professionals will argue that these loads and 12b-1 fees are the price you pay in exchange for their sage investment advice.
So how has their advice been working for you over the last ten years?

If you’re up 100% after these fees and charges since 1999, then I say “God Bless”.
But most of these loaded funds have at best been “market performers” and the market (e.g. the S&P 500 index) has actually lost money during the last decade. Some of the best mutual funds you can buy, with truly awesome track records, don’t need to offer sales incentives like loads or 12b-1 fees to convince people to buy them. These funds sell themselves because they have a strong track record. These are the funds that you should buy or insist your advisor buy for you.

So how can you discover what you are paying and what you should buy? Go to www.morningstar.com. At the top of their home page, enter the name of the fund you own or that your broker/advisor is recommending. The fund page will reveal a wealth of useful information, including all you need to know about sales charges under the “expenses” category on the horizontal gray bar.

Now that you are gaining an understanding of exactly how much it has and is costing you to hold these “A”, “B”, and “C” shares for, at best, market performance, what can you do? Either get out of mutual funds entirely and buy exchange traded funds which have fees as low as 0.30% and none of these questionable kick back practices, or if you still prefer mutual funds, then insist on no-load funds without 12b-1 kick-backs.

Posted in A Few Dollars More, Portfolio Advice, The Fund House