No-load mutual funds are often touted as the only way to go. You may hear that loads reduce your investment principal, limit your flexibility and eat up your profits. But what exactly is a load?
As unattractive as it may sound, all a load is, really, is a sales commission paid to a broker or financial adviser who helps you make decisions and invest your money.
Loads are only part of the picture
The Mutual Fund Investor's Center lists a total of 20,362 mutual funds, of which 6,049 have loads and another 3,870 have "low loads." Altogether, that makes about 49 percent of the total number of funds. And the Investment Company Institute reports that more than $33 billion of net new cash was invested in load funds in 2006, and another $14 billion flowed in these funds in 2007. If loads are always a bad idea, why do they seem to be so popular?
Loads are just one part of the investing picture, and a savvy investor will consider all costs of an offering, including loads (which come in a variety of types, some of which might actually jibe with your strategies and goals), management fees and trading costs, as well as all potential returns, before making a decision. Click on Bankrate's chart for a rundown of the different types of loads, and their pros and cons.
If you want to avoid loads, you have two choices: Do all your own investing or compensate your adviser in some other way.
The first is certainly an option, and it's what many of the experts have in mind when they tell you to stick with no-loads. After all, do you really need a highly trained market analyst to tell you to buy an index fund? No, that's why we have index funds -- so casual investors can benefit from the market without specialized knowledge of individual stocks.
Asset allocation or bust
But what if your investment goals and strategies are more complex than that?
"Asset allocation is the No. 1 factor in total return over time," says John Magadini, a financial adviser with M.L. Stern & Co. in San Francisco. Suppose you're investing not in index funds, he explains, but in sector funds that focus on specific industries. Your technology sector funds go way up (or way down) and suddenly they're representing a disproportionate part of your portfolio. A good adviser will stay on top of this kind of change and let you know when and how to make adjustments in your portfolio.
Bob Emmer, a financial planner in Mill Valley, Calif., believes that many people do need assistance with financial management -- even some who don't realize they do.
"Cocktail party tips are only on the buy side," he points out. "Nobody tells you when to get out." If you have an adviser managing your trades, he deserves to be paid. But should you pay a load when you're buying directly? "Of course not," says Emmer. The key question you need to ask yourself, he says: Is this person adding value?
Loads are one way, though not the only one, to pay for investment assistance. Your broker or adviser selects and purchases an appropriate fund for you and gets a commission of several percent of your investment. Not an inherently bad thing; lots of people work on commission.
But if you prefer to compensate an adviser in some other way, you probably can. Many charge an hourly fee or take a small percentage of the value of your assets in exchange for managing your money. If they work under one of those arrangements, they shouldn't (and probably won't) charge you loads on the funds they purchase.
So what difference does it make? Your overall goal is to maximize your returns and minimize your expenses, not to quibble over what kind of expenses you want to pay.
Suppose, for example, you hire a financial planner who spends two hours learning about your investment goals, charges you $100 an hour and advises to you to put $4,800 into a no-load fund. Is that any different from going to someone who spends two hours talking with you and then puts $5,000 of your money into a fund with 4-percent load and earns a $200 commission? Not really.
But of course you don't ride free, even after you're in. Remember that a load is not the only cost of investing. Make sure you've taken all fees and expenses into account.
Costs that occur in load and no-load funds:
- 12b-1 fees: Also known as marketing fees, distribution fees, service fees and hidden loads. A fund can legally charge a 12b-1 fee of up to 0.25 percent of its net assets and still call itself a no-load fund. Load funds often charge up to 1 percent. 12b-1 fees are disclosed in the prospectus.
- Expense ratio, or management expense ratio, or MER: This includes investment advisory fees, administrative costs, other operating expenses and the 12b-1 fee. The expense ratio will be in the fund's prospectus, expressed as a percentage of the total fund assets.
- Redemption fee: A redemption fee, or "short-term trading fee" may be charged at the time you sell your shares, just like a back-end load. This is limited, by SEC regulation, to 2 percent of your investment. But because it's not included in the expense ratio (above), remember to add it into your calculations if your fund has one.
- Trading activity costs: This refers to the costs of buying and selling the securities within the fund's portfolio and it is passed along to the shareholders but is not included in the expense ratio. To get an idea whether the fund you've picked will have high trading costs, check its turnover ratio, which tells you how often the fund's holdings have been replaced within the year.
The self-help savants are pretty much on target. If you enjoy doing your own investing and you can find no-load funds that meet your investment goals and have reasonable expense ratios, then go for it. Just remember to think about the full picture before you reject an option out of hand.