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Why
You Should Buy No-Load Funds! |
Load is defined as the fee or the commission
that an investor pays to a mutual fund at the time of purchasing or
redeeming the shares of the mutual fund.
If the commission
is charged when the investor buys the shares, it is known as a
front-end load. On the other hand if the commission is charged when
the investors redeems his shares, it is known as a back-end load.
Certain funds apply back-end loads only if the shares are redeemed
within a specific time period after being bought.
The
argument for applying loads on mutual fund transactions is that
these loads will discourage investors from trading frequently in
mutual funds. If the investors quickly move in and out of mutual
funds, the funds have to maintain a high cash position to meet these
redemptions, which in turn decreases the returns of the funds. Also
frequent trading means the expenses of the mutual funds go up.
There are various arguments against load funds:
-The fees
that the mutual funds collect as loads are passed on to the fund
brokers. The loads do not provide any incentive for the fund manager
for better performance of the funds. In other words, a load fund has
no reason why its managers should perform better than those of
no-load funds.
-In the last few decades, no difference has
been seen in the returns of load and no-load funds (if the loads are
not considered.) When the loads are considered, the investors of
load funds have actually gained less than the investors of no-load
funds.
-When a sales person knows that he is going to get a
commission from a load fund, he tends to push the load fund more -
even when the load funds are performing poorly as compared to
no-load funds.
-Loads are understated by mutual funds. If
an investor invests $1000 in a fund with 5% front-end load, the
actual investment is only $950. Thus his actual load is $50 in $950
investment - a 5.26% load.
If an investor is already
invested in a load fund, it doesn't make sense to exit now. The load
has already been paid for. The hold or sell decision should now only
be based on what the investor thinks about the future performance of
the fund. In a few funds, the exit load depends on the period for
which the fund was held.Check the details of the fund prospectus for
more information.
In most cases it is better to avoid load
funds; however, investors should keep one thing in mind. Sometimes
load funds can be a better choice than no-load funds. For example,
an investor has a choice of two classes in a fund - class A and
class B. Class A has 3% front-end load and Class B has no load. The
investor however misses the fine print, which states that Class B
has 1% 12b-1 annual fees.
If the fund will make 10% gains
each year, its return in Class A (starting with actual amount
invested $970) will be
($970) X (1.10) X (1.10) X (1.10) X
(1.10) X (1.10) = $1562
For Class B, the returns will be
($1000) X (1.10) X (0.99) X (1.10) X (0.99) X (1.10) X (0.99) X
(1.10) X (0.99) X (1.10) X (0.99) = $1532.
Thus the above
example is an exception, where in the long run, the load fund will
perform better than the no-load fund (with 12b-1 fees).
The
fact is that a no-load fund cannot be considered a true no-load
fund, if it charges fees from it's investors in the form of 12b-1
and other fees.
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