ABCs of Mutual Fund Loads

Investing Intelligently had a post, When is a Front End Load not a Front End Load?

I thought I would break down the ABCs of Mutual Fund Loads.  How much are you really paying?

We have all heard that there are Load and No-Load funds that we may choose from.  A load, put simply, is a sales charge.  This is the amount that is paid to the broker who is selling you this particular mutual fund.  Most of the advice that you will find online and in books tells you very specifically to stay away from costly load funds, and stick with cheap no-load funds.  Good advice, but not necessarily as easy as it sounds.

One of the biggest problems is that the clever load funds vary the way that they charge you.  This way, if you are looking for the front load, you may not find it, yet still get charged the same amount or more.  How do they do this?  They do it by utilizing the ABCs of loads. 

Loads are typically charged in one of three forms.  They are called share classes.  You may buy A shares, B shares or C shares.  Sometimes there are other options, but these are the most common.  Let's pick on The Growth Fund of America of the American Funds family.  According to Yahoo, this is the largest mutual fund in the country based on total assets under management, with a whopping $78 Billion!  Of course, the load isn't the only expense, so I'll break the other costs down as well.  Note:  all of the information regarding The Growth Fund of America was obtained from the prospectus, dated November 1, 2005.  I am not responsible for any inaccuracies, or discrepancies from that document.  I am not recommending this fund, simply using it as an example of how mutual fund loads work.

Class A Shares

A-Shares are the traditional front load.  The percentage varies, but around 5% for equity or balanced funds is common.  Looking at The Growth Fund of America, they charge a front load of 5.75%.  So, if you invest $10,000 in this fund, you immediately have a balance of $9,425 to go to work.  The percentage decreases as the amount you invest increases.  If you invest $25,000 the front load is 5.00% on the entire amount of investment from the first dollar.  At $50,000 it is reduced to 4.50% on the amount invested.  The dollar amount at which the load is reduced is known as the Breakpoint.  Not only does your cost go down at these breakpoints, but the broker's commission also goes down.  For example, in the Growth Fund of America, the broker is paid 5.00% for any investment that is charged the full 5.75% load.  If you are investing at least $25,000 but less than $50,000, your load is 5.00%, and the broker's commission is 4.25%.  It is illegal for the broker to encourage you to buy just under the breakpoint in order to earn a higher commission.  The breakpoints continue until $1million, at which point the front load goes to zero.

The other expenses involved are Management Fees (for the portfolio management), Distribution fees called 12b-1 fees (more sales costs), and Other expenses (legal, bookkeeping, etc.).  In the case of The Growth Fund of America the Management Fees are 0.29%, 12b-1 fees are 0.25%, and Other Expenses are 0.14% for a total of 0.68% annual expenses.  The 0.25% 12b-1 fees are generally paid to the broker as on-going compensation, commonly called a trailer. 

But the idea that you invest some money, and immediately have a lower balance is hoping to make it up in growth is unpleasant to many.  Thus the mutual fund industry invented a way to buy the costs.

Class B Shares

Class B shares have zero front load.  You put in $10,000, you start with $10,000.  Your broker even gets paid a little less.  In The Growth Fund of America, the broker's commission is 4% of the amount invested.  Sounds like a good deal for the investor, right?  Well, let's look at the other expenses.

Growth Fund of America:  Management Fees, 0.29% (that's the same); 12b-1 fees, 1.00% (ouch); Other Expenses, 0.14% (that's also the same).  So, it costs you 0.75% more per year.  The additional cost continues for eight years, after which your shares convert into class A shares.  So, a simple way to calculate this is to say .75% x 8 = 6.0%.  But that wouldn't be accurate math.  Suffice it to say that B shares can be and often are more expensive over time than the already expensive A shares.

Also, after investing in B shares, should you decide to take your money out, whether for another investment or an emergency, you are charged a penalty (called the contingent deferred sales charge).  In The Growth Fund of America, the penalty is 5% in the first year, 4% in either the 2nd or 3rd year, and decreases 1% per year until it goes away in the 7th.

Class C Shares

Many brokers attempt to "build a book" of clients and keep their holdings long term.  Class A and B shares pay most of their commission up front.  Class C shares pay the broker less up front, but more ongoing commissions, allowing them to "annuitize" their business.

Class C shares generally do not have a front load.  Generally, there is a 1% contingent deferred sales charge if the fund is sold in the first year.  Sounds good, right?  Well, it's more flexible at least.  But not cheaper.

Expenses in The Growth Fund of America:  Management Fees, 0.29%; 12b-1 Fees, 1.00%, Other Expenses, 0.19%.  The annual expenses are 0.80% greater than Class A shares.  Class C shares do not convert to A shares.  The higher expenses are on going forever.  If you hold these for 10 years, you will be paying very high expenses.

In the end, I would concur with most of the internet and book writers out there.  Stick with no-load funds.  However, check the expense ratios.  Some may not have loads, but charge very high Management Expeses or Other Fees.

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Great to see this article.
Too many people don't know just how much they are throwing away with loads.

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