10 things you need to know about No Load mutual funds

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This is a piece I’ve been looking forward to writing for some time. And what does that mean to you? I’m really not too sure, other than it’s probably going to be a longer post than normal, so lets get to it.

But before we start I have to tell you… I’ve never sold a No Load mutual fund in my life so I ask that you bear with me. That’s an inside joke…

I’ve never sold a no load mutual fund because they are NEVER SOLD by financial advisors. I’ll explain why that is and a whole lot more on the list below…

First things first, if you’re new to investing, click here for a brief summary of what a no load fund is. For the rest of you that are somewhat familiar with no load mutual funds, lets get started.

A tug of war

In a couple different posts this week I’ve talked about the never ending debate over deciding which is a better investment, an A share or a C share. Well that discussion pales in comparison to the one over which is the better way to invest your money… using load funds or no load funds?

If you go online you can find information defending both points of view. Although you will find a lot more articles about why No load funds are the way to go, simply because there are far less fees.

The reasoning is… why pay for something when you can get it for free. (At the bottom of this page I will include a few links that articulate that point of view quite nicely.)

And I think that reasoning is fair enough. But I also think you have to be careful to look at things in their proper context, not in a vacuum. When you step back and look at your investments and the bigger picture (a.k.a. within the context of a financial planning relationship) things aren’t as cut and dry.

10 things you need to know about No Load mutual funds:

1. There is no upfront sales load or deferred charge (CDSC) associated with no load funds. Hence the title: No Load funds. Because there are no costs, you start with the amount you planned to invest. If you want to sell your shares, you can do so at anytime, without penalty.

2. No Load mutual funds are purchased directly from the fund family itself. This is the biggest reason the costs are so low. And the major difference between No Loads and Loaded funds.

Loaded funds are only purchased through advisors in a distribution channel, whether that channel be a bank, wire house or independent advisor. No loads cut out this whole step, they cut out the middle man and the costs associated with the middleman.

• If you look at the standardized fee chart from the last post, you will see a line (third from the bottom) titled: Distribution and/or Services (12b-1) fees. That is the toll that mutual fund companies pay to get their funds sold (and marketed) through, the aforementioned, distribution channels.
• The fund indirectly passes those costs on to all the fund investors, which is illustrated via the (12b-1) line item.
• Maybe an analogy would do some good here. For example, it would be like the cost a consumer product company would pay a supermarket, pharmacy or a Walmart, to get their product on the shelves.
• Moral of the story… if you want to play in that game you gotta pay for the exposure.

3. The operating costs and expenses are lower for No Loads. Because there are no upfront commission charges or fees to get the product on broker shelves, the costs passed on to fund investors remain low.

• Once again, using the fee chart as an example, if you were to put “None” in the first two fields going down the page (upfront and deferred charges) and pencil in”None” in the distribution/Service (12b-1) field - (product placement fee) you’d get a rough estimate of the internal costs for owning a No Load.

4. Although No Loads are cost effective, there are smallish fees that may be assessed by the fund family itself. To be clear, these transaction fees are paid to the fund, not any broker (or advisor).

• Purchase fees- a fee to purchase the fund directly from the fund family
• Redemption fees- a fee to sell the fund or redeem the fund shares

5. Generally, there is no advice that comes with purchasing a No Load. Because the middle man (financial advisor) has been cut out of the equation, you are on your own when it comes to managing your investment portfolio. If you can handle your investments on your own then more power to you.

6. If a fund’s annual 12b-1 fees are lower than .25% it can (technically) be called a No Load. There are some No Load funds that are not “true” No load funds. They actually may charge a fee (i.e .15%) that ironically is very similar to the expense ratio of some ETF’s:

• for example, State Street’s SPDR 500 ETF (which tracks the S&P 500) has an expense ratio of .11%.
• some ETF’s (especially the more exotic ones) will have higher expense ratios

7. Although no loads have no client charges and don’t pay (12b-1) fees, they are still mutual funds and there are still fees. Generally speaking, ETF’s are more cost effective than No Loads. For the following example, please refer back to the standardized fee schedule:

• Management Fees - 1% - still apply to No Loads
• Other expenses- .89% - still apply to No Loads - need to keep the lights on, pencils sharpened, lawyers paid, etc. (cost of expenses will vary, this is just one example)
• Add these two together and you’re looking at 1.89%; the average ETF has an expense ratio somewhere in the neighborhood of .40%, with some of the better known ETF’s under .20%.

8. At the end of the day, the difference in cost between a No Load fund and a Load fund is the cost of having a financial advisor in the picture. If you want to make an apples to apples comparison, load funds come with an advisory relationship and no loads don’t.

Whichever way you decide to go is up to you. It should depend on a number of factors, including:

• how comfortable you are handling your own investments
• your acumen for all matters financial
• how much time and effort you can afford to give to managing your investments
• the premium you put on financial planning, if any. (Remember: a relationship with a trusted financial advisor may go way beyond the scope of just investing. A good financial planner acts like an emotional compass for most clients.)

9. If your heart so desires, you can have it all! An ETF based portfolio, a financial advisor, a financial plan and still compete with No Loads from a pure cost standpoint. If you noticed in #8 I said, “the difference in cost between a load fund and a no load fund is the cost of a having a financial advisor in the picture.”

Pay special attention to the words, ‘between a load fund and a no load fund.’ With ETF’s you can have the best of both worlds- an efficient cost effective portfolio and the help of a financial planner. How? Lets breakdown it down:

• ETF expenses - .40% (average expenses)
• fee based advisor cost - 1%
• total cost - 1.4% (comparable to an investor with No Load funds and no advisor relationship)
• financial planner in your life - Priceless (haha)

10. If 100% of retail customers owned nothing but No Load mutual funds, then fee based advisors like me, would be out of a job. Although, fee only advisors would probably survive.

Obviously, this will never happen… but I’m exaggerating to make a point. In fact, the majority of mutual fund investors own load funds.

• Is this because of the massive amount of money mutual fund families spend on marketing and distributing load funds? or

• because most people prefer the advice of a financial advisor?

I think its probably a combination of both.

Summary

No loads are the most cost effective mutual funds because they spend little to nothing on marketing; relying heavily on word of mouth and financial media to get the word out. They are the viral darlings of the mutual fund world…

Here are some links to a few informative articles on No Loads:

The advantages of No Load Mutual funds

No load funds can be an excellent deal

Mutual fund costs

Tags: Advisor Compensation, ETF, Mutual Funds, No Loads