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Please Stop Paying Commissions for Loaded Mutual Funds!

the fine print
There’s nothing to see here. Please move on.

“Getting and spending, we lay waste our powers.”
–William Wordsworth

I’ve been there. I’ve suffered from the siren song of a chart pornist who wants to show you beautiful charts that somehow convince you that paying a 5.9% front load on a mutual fund ensures that, somehow, some way, the mutual fund is going to outperform the market. “We’ll have money when the market tanks,” the chart pornist sings his siren song, “so we can buy even more when everyone else is running away!”

In theory, this approach would work if a) it was impossible to value cost average, b) NOBODY else did it, and c) the loads weren’t so high that they didn’t cripple your investment ability, giving everyone else such an enormous head start that it’d take a ton of down days followed by a record-setting up day before that strategy could work.

But, this is the real world, not the one that the “investment advisors” who work at strip mall “financial planning” firms like to present to you as reality. Even the great Dave Ramsey, whose work at getting people out of debt I admire greatly, has an endorsed local provider (ELP) network whose advisors make their living off of charging commissions for investing in mutual funds. He claims that his investments gain 12% on average, except that front loads take 5.9% off the top, and, active management comes replete with its own risks that effectively relegate active mutual fund investing to the realm of rolling loaded dice.

However, up until now, I’d struggled to find any hard data to support my gut feeling that paying a mutual fund load and disproportionately high fees was akin to lighting your money on fire.

Until now. Thanks to Sandi Martin at Spring Personal Finance in Barrie, Ontario, Canada, I have found the data. Craig Israelsen in Financial Planning Magazine did a study of front loaded mutual funds compared to their non-loaded mutual fund equivalents.

Before I dig into the results, let me take a moment to remind everyone what a mutual fund load is and how you can find these loads.

First, let’s answer the initial question:

What is a mutual fund load?

A mutual fund load is a pretty name for a salesman’s commission. It is simply money going from your pocket to a salesman’s pocket for introducing you to the wonderful wallet-gouging world of loaded mutual funds. Back a zillion years ago when you couldn’t invest in stocks or mutual funds yourself and needed to call up a broker, who would help guide you through the minefield of investing, paying a small fee for someone’s services was reasonable. Nowadays, it’s not reasonable. I’ll explain more why in a minute, when we see the data, but let me implant something perfectly and crystal clear in your mind.

There is no reason in the world for you to pay a mutual fund load. None. Fin. Period. End of story. If someone tells you that you should pay a load, it is because he wants a piece of your money without earning it.

Now that we’ve established the true intent behind mutual fund loads, let’s look at:

What Are the Three Types of Mutual Fund Loads?

There are three versions of evil mutual fund loads.

  1. Class A, front-loaded mutual funds. A Class A fund means that you’re paying the commission right when you make the purchase. If a mutual fund front load is 5.9%, and you’re investing $1,000, then you’re going to invest $941 in the actual fund’s shares and you’re going to give your salesperson $59 to reward him for steering you down this path to doom.
  2. Class B, back-loaded, contingent deferred sales load (CDSL), or contingent deferred sales charge (CDSC) funds. This one is, in my opinion, the most deceptive of the loads. You pay a fee if you leave the fund within a certain time. The fee which you pay usually decreases over time, starting out at 5% if you sell within a year, and decreasing 1% each year until you could leave “scot free” after the 5th year. There’s one small problem. You won’t leave scot free. What these funds do is increase the 12b-1 fee to 1% each year so you wind up paying anyway. We’ll explain that next.
  3. Class C, level load. This is a fund which charges higher than a 0.25% 12b-1 fee. The 12b-1 fee is for operating and marketing expenses. If a mutual fund has a 12b-1 fee of higher than .25%, then it is not allowed by the SEC to call itself a “no load” fund. The statutory limit for a 12b-1 fee is 1%, so guess what loaded mutual funds are going to charge? Yes, you win a kewpie doll. They’re going to charge 1%. Remember when I showed you that financial planners who charged you 1% of your assets under management were slowly, surreptitiously siphoning away your money and charging you for what was almost assuredly underperformance in your investments? A 1% 12b-1 fee accomplishes the same thing.

As I have said before, all of these load fees would be fine if you were paying for performance which far exceeded the costs involved. The problem, as the Israelsen study points out, is that you’re not getting superior performance.

No-load funds outperformed loaded funds in all nine of Morningstar’s mutual fund categories. The “best” load fund performance class was in mid-cap value mutual funds, where no-load funds outperformed load funds by only .1%. The worst was in small cap growth mutual funds, where no-load funds outperformed load funds by 4.3%.

If you hold these funds outside of tax-deferred or tax-free retirement accounts, then you may see slightly better performance due to capital gains; however, loaded funds still underperform in ALL NINE categories. The “best” performer is mid-cap value mutual funds, but those loaded funds still underperform by .1%; the worst performer is still small cap growth, with an underperformance of 3.4%.

To compound the problem, the loaded mutual funds are actively managed funds. Actively managed funds underperform their index fund brethren across the board. Once we remove the survivorship bias from numbers and include funds which closed, underperformance ranged from 3.56% underperformance for large value stocks to 5.9% underperformance for mid blend stock funds.

Combine the actively managed fund underperformance numbers and the load drag, and you get a very ugly picture.

Total Underperformance
Large blend -4.03%
Large growth -2.86%
Large value -2.26%
Mid blend -2.74%
Mid growth -3.71%
Mid value -0.47%
Small blend -6.03%
Small growth -7.80%
Small value -4.05%

Now, let’s assume that you invest $5,000 per year over the next 30 years. Below is how your investments will compare if you invest in a fund which matches market performance versus a fund which is an actively managed loaded fund. You can see results for each class of mutual fund given different growth rates. My apologies for the vision test! Losses are indicated by $(amount).

Compound average annual growth rate Large blend Large growth Large value Mid blend Mid growth Mid value Small blend Small growth Small value
0% $(65,597.16) $(51,279.17) $(42,737.05) $(49,630.98) $(62,034.59) $(10,360.93) $(84,148.28) $(96,073.01) $(65,816.66)
1% $(81,023.26) $(63,829.48) $(53,534.69) $(61,845.06) $(76,753.35) $(14,332.10) $(103,145.73) $(117,234.05) $(81,286.14)
2% $(100,230.27) $(79,497.92) $(67,042.97) $(77,099.26) $(95,090.78) $(19,410.07) $(126,732.31) $(143,460.63) $(100,546.47)
3% $(124,181.83) $(99,087.23) $(83,965.52) $(96,177.40) $(117,971.21) $(25,907.45) $(156,066.71) $(176,025.21) $(124,563.69)
4% $(154,088.43) $(123,607.49) $(105,188.92) $(120,065.89) $(146,556.11) $(34,223.98) $(192,602.47) $(216,523.14) $(154,551.28)
5% $(191,469.81) $(154,328.76) $(131,829.50) $(150,005.42) $(182,304.20) $(44,870.17) $(238,162.19) $(266,953.76) $(192,032.72)
6% $(238,232.78) $(192,847.03) $(165,291.88) $(187,555.33) $(227,046.27) $(58,497.12) $(295,029.98) $(329,821.41) $(238,919.47)
7% $(296,768.07) $(241,166.17) $(207,341.88) $(234,673.94) $(283,078.42) $(75,934.07) $(366,066.44) $(408,261.10) $(297,608.05)
8% $(370,070.78) $(301,800.10) $(260,197.50) $(293,818.54) $(353,278.02) $(98,235.66) $(454,851.58) $(506,194.72) $(371,100.77)
9% $(461,889.99) $(377,899.78) $(326,642.03) $(368,069.69) $(441,247.79) $(126,741.18) $(565,862.23) $(628,524.80) $(463,155.67)
10% $(576,914.30) $(473,410.76) $(410,164.63) $(461,285.57) $(551,494.42) $(163,148.86) $(704,691.93) $(781,374.81) $(578,472.48)

Hopefully I’ve convinced you of the horrors of loaded mutual funds. There are no positive returns in that chart.

But, there is still one big question to be answered.

How can I tell if a mutual fund has a load?

If, for some reason, you’re using a broker, ask him or her what the load is. He’s required by law to tell you.

If you’re purchasing funds online, you can simple go to Google Finance and type in the mutual fund symbol. Let’s look at an example, the Templeton Global Bond Fund Class A. To find the load, simply scroll down some and look on the right for this piece of information:

Templeton Global Bond Fund Class A Fees | PLEASE Stop Paying Mutual Fund Load Fees! | Hull Financial Planning
This is a perfect example of exorbitant and unnecessary fees (source: Google Finance)

First off, the name Class A gives it away. It’s a front loaded mutual fund. Secondly, the front load in the Key Statistics section tells you that you’re handing 4.25% of your investment straight to the salesman. He thanks you.

Looking up a load is that simple. The name will include the class (A, B, or C) if there is a load. If there’s no class, then check in the Key Statistics section to verify that there’s no load. Better yet, use a screener that can return no-load funds.

In a time when luck plays an increasing return in investment results, there is no reason to pay a salesman a commission just to throw dice which are loaded against you.

Let me be clear on two things:

  1. I don’t manage money for you. There is absolutely no conclusive reason I can find in any of the studies and academic research to believe that I can outperform the market in a meaningful and consistent way, particularly in one which would justify charging you an assets under management fee. If you run into an advisor who insists on managing your money for you, then ask him or her to first justify and conclusively counter the statistical evidence provided here.
  2. I will never recommend you invest in loaded mutual funds. The evidence is simply too strong, again, to justify taking that approach over the long term. I cannot see how being a picker provides comprehensive and sustainable returns above the market over the long run. You might get lucky a few times and beat the averages. However, the statistics say that if you invest in loaded mutual funds, you’ll be unlucky more often than not. The home runs you’d hit won’t account for all of the strikeouts.

Have you ever invested in a loaded mutual fund (I have, sadly)? Were you happy with the results (I was not, sadly)? Tell us about your experiences in the comments below!

By Jason Hull, CFP®

5 replies on “Please Stop Paying Commissions for Loaded Mutual Funds!”

My spouse and I spent most of the 1980s (and perhaps part of the ’90s) paying Fidelity’s “sales charges” on their Puritan & Equity-Income mutual funds. (Those were the funds that Dad invested in, so they were “good enough” for us kids.) We paid a 2% charge because that Peter Lynch guy (and his successors) over at Magellan wanted 3%, which seemed to be an awful lot to pay for a mutual fund…

The only reason to be happy was because we were investing during the 1980s & 90s bull markets. (We especially enjoyed going all-in after 1987’s Black Monday.) If we’d been paying those loads in the 2000s we would have quickly realized there was a problem and gone elsewhere.

Blissfully ignorant we were, but back before the Web we were doing it with Business Week’s annual “Where to Invest!” magazine and an occasional Fidelity newsletter. And that was only when we were on shore duty.

Do you ever play the “what if I hadn’t paid those loads?” game?

Come to think of it, don’t. Unless you find yourself exuberantly happy one day after a great morning of surfing and need to counterbalance the happiness.

I have never paid a single sales load. I was lucky enough to learn the virtues of index fund investing early on and have since seen no reason to place my money anywhere other than Vanguard. My favorite investment book of all time is David Swensen’s Unconventional Success, which lays out all of these points incredibly well. Every dollar you pay in fees is many dollars less you have later.

Before the author beats himself to death by pounding his own chest, I submit that although I agree with him that index funds are a better buy than loaded mutual funds, there are MANY people who would never have begun saving and investing money AT ALL had it not been for sales brokers convincing them to do that. Many of those salesmen earn a living by selling funds with sales loads. Even if someone invested $5,000 a year for 30 years and got NO return on that money year after year because of fees (obviously not realistic) they would have still had $150,000 that they would not have put away had someone not convinced them that they needed to save.

Hi William–

Thanks for commenting! I’ll try not to break my own ribs with the chest pounding. I am a pain weenie, after all. I guess all that time at West Point and in the Army didn’t do anything for my toughness. My first sergeant would be disappointed.

Just because an industry (in this case, commissioned sales brokers) is the biggest industry does not mean it’s the best industry. I agree with you in that I’d rather people invest in crappy front-loaded mutual funds than not invest at all, because, in all likelihood, over 30 years, they’ll wind up better off than they would have had they not invested at all.

However, making that argument is similar to making the argument that if someone is recommending continuing to use sandals for running marathons a la Pheidippides, it’s better than them running barefoot, despite the shoe industry having actual running shoes available for those marathon runners.

If there are people who are not investing now, then there are many, many, many avenues for them to learn about how to do so without flushing their money down the toilet handing their money to a commissioned sales broker. Go back and look at the chart comparing returns. The smallest transfer of wealth was $42,737.05. That’s an extraordinarily high cost of education. No financial planner who is worth his socks should cost that much.

Why, then, do you suggest that people should take the “better than nothing” approach? Wouldn’t you rather see people be successful and not get robbed blind in the process?

Sure, based on your argument, that commissioned salesman did a “service” to the person, but he also extracted a king’s ransom in the process. There are far better ways to get those people who would not otherwise invest $5,000 per year to do so that do not involve tying an anchor to their nest eggs.

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