Tuesday Talk: Front-End Load Mutual Funds

Front-End Load Mutual Funds

There are a number of mutual funds out there. Today, I want to talk about front-end load mutual funds. Front-end load mutual funds charge commissions or sales fees at the time of the initial purchase. What does that mean? Let’s say you are putting $5,000 towards purchasing an investment fund with a 5.5% front-end sales load. The brokerage will deduct $275 ($5,000 x 5.5%) from the investment, then use the rest ($4,725) to purchase the mutual funds. Historically speaking, front-end load funds haven’t really outperformed other types of mutual funds or Exchange Traded Funds (ETFs). More importantly, historically speaking most mutual funds and hedge funds (90%) didn't outperformed any stock market index.

Here is a nice comparison from yahoo.com that shows the problems with front-end (and back-end) load mutual funds:

Assuming a $10,000 investment with a conservative nine percent annual net return rate (after annual fund operating expenses) over three years, the following illustrations compare the differences in total return and Return on Investment (ROI) among three different types of mutual fund sales structures:

* 100% no-load (no 12b-1 fees)

* 5% front-end load with 0.5% per year 12b-1 fees

* 3% back-end load with 0.5% per year 12b-1 fees (redemption in year 3)

Total Return Comparison
	Start	Year 1	Year 2	Year 3
100% No-Load	$10,000	$10,900	$11,881	$12,950
5% Front-End Load	$ 9,500	$10,303	$11,174	$12,119
3% Back-End Load	$10,000	$10,845	$11,762	$12,374

Cumulative ROI Comparison
	Year 1	Year 2	Year 3
100% No-Load	9.0%	18.8%	29.5%
5% Front-End Load	3.0%	11.7%	21.2%
3% Back-End Load	8.4%	17.6%	23.7%

As far as cumulative ROI after three years in this illustration, the 100 percent no-load fund outperforms the five percent front-end load fund by 39.3 percent and the back-end load fund by 24.4 percent -- even though a nine percent annual return rate is identical for all three funds! The ROI advantage of the 100 percent no-load fund in this illustration is due entirely to the absence of both sales load and annual 12b-1 distribution fees. The advantage of the 100 percent no-load fund in these illustrations is obvious. Comparative ROI differences would be even more dramatic as the annual return rate parameter falls below nine percent and less dramatic as the annual return rate parameter rises above nine percent.

Does this imply that all no-load funds are superior to all load funds? Of course not. Obviously, a five percent front-end load fund with a 15 percent annual return will outperform a no-load fund with a nine percent annual return. However, no-load funds that carry above average rankings (from Morningstar or Lipper) will most likely outperform load funds, provided that the funds are in the same fund category (i.e.; growth, growth & income, global, corporate bond) with a time frame of at least three years.

Finally, you should be aware of custodial fees or managerial fees. Recently, a major brokerage firm announced that it would be offering no-load funds from 28 fund families without charging commissions or 12b-1 fees. However, this firm will compensate salesmen by charging clients up to 1.5 percent of their assets on an annual basis. Over a relatively short time, these fees would be substantially greater than even a five percent front-end load! It is best to avoid these types of fees and maintain the no-load advantage. (http://finance.yahoo.com/funds/how_to_choose/article/100601/Load_vs__No-Load_Funds)