When eating out, sometimes you pay when you place your order and sometimes you pay after you've eaten. Mutual funds are similar. You pay sales fees, or loads, when you enter some mutual funds. This is called a load fund. With others, you don't pay a load when you buy the fund. This is a no-load fund. Once you learn the ins and outs, you can decide which type of load works best for you.
Advantages of No-load Funds
When you buy shares in a no-load fund, you don't pay a sales fee at the time of your purchase. That means all of your money goes to work right away. For example, if you have $1,000 to invest, you can buy $1,000 worth of shares in a no-load fund. Another advantage is that you can more easily compare the performance of your fund to the overall stock market. In other words, since you didn't take a percentage upfront to pay a sales fee, you don't have to make up that percentage. If the stock market goes up 10 percent, for example, and your fund goes up the same percentage, you know your profits are matching the market. If you had to take out 2 or 3 percent upfront to pay a sales load and your fund rose as much as the market, you would actually be behind.
Disadvantages of No-load Funds
The name "no-load" is a little misleading. You actually pay a fee when you sell your shares. You may pay as much as 4 percent of your portfolio value at the time you sell. This can make your returns deceptive. For example, if you thought you had shares worth $20,000, after selling and paying a back load of 4 percent, you would find that you had $19,200 coming to you. Notice that a back-loaded fund charges you a percentage of your investment's final value. The fee isn't based on how much money you first put in. You will also pay management fees in addition to the back load. All funds charge amounts to cover their expenses for operating. However, no-load funds typically charge higher management fees to make up for the lack of an upfront sales fee.
Advantages of Load Funds
Loaded funds take all the mystery out of sales charges. You pay the fee at the time you purchase your shares. Since you will not have to pay anymore sales charges, the value of your investment on any given day is the actual amount you could take out. Management fees are lower for load funds because the fund doesn't have to make up for a missed sales fee. You don't have to come up with the cash for management fees. Funds take this fee out of the portfolio value. For example, if your shares are worth $26, they would have been worth $26.52, but the fund took out 2 percent as a management fee. Because you already paid your load, you can redeem your shares at the share price listed and get all your money without any additional fees.
Disadvantages of Load Funds
Because you pay your sales load upfront, you'll get fewer shares to start out with. For example, if you have $10,000 to invest, you would have to pay $400 for your front load if you were charged 4 percent. You could only buy $9,600 worth of shares. If your investment goes up $400 in value, you have only broken even. It can be very hard to track your progress in relation to the overall market since you started off behind. In our example, since you paid 4 percent upfront, if the market goes up 10 percent and your fund goes up 10 percent, you really only made 6 percent. Your fund has to outperform the market to make up for your upfront load.
When to Use Each
The historic performance of load funds and no-load funds is about the same. No-load funds make sense when you know you're going to leave your money in the investment long enough to make up the sales fee and realize some profits. Because of the lower management fees on these funds, your long-term investment costs you less in ongoing fees. Load funds are appealing when you want to get all of your money to work as quickly as possible. You can buy more shares at the beginning and take advantage of any rise in the fund’s share price.
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