The Worst Fund Advice Ever
We’ve been telling investors for years that they should never, ever buy a load fund, be it a front end, back end, or the intentionally deceptive level load funds. Loads are built in sales commissions primarily used to compensate brokers who sell funds to investors.
The gist of our anti-load argument is simple: there is no difference between load and no load funds other then the added sales commission. It’s like running a race with wet boots on – you’re at a disadvantage from the get-go.
But has our anti-load proselytizing been wrong all these years? If you had read a recent article in Investors Business Daily, you might think so. In it the case is made that individual investors should sometimes choose load funds over no load funds. The main concepts in support of this argument are:
1. Whether to go no load or load should not be your first decision when picking funds
2. There are more important decisions then whether the fund is load or not
3. If a load fund has a better performance record then a no load fund, you should go with the load fund
4. Few load funds have identical no load twins
5. Over the long haul loads only add about .44% a year in extra expenses
Our response to the article? It is complete and utter nonsense.
Here’s our point by point rebuttal:
1. Whether to go no load or load should not be your first decision when picking funds.
There is no difference between load and no load funds other then that one (load funds) has a built in sales commission to compensate brokers to sell the fund and one (no-load) does not. The management fees are the same, the management quality is the same, the categories are the same.
If there were two electronics stores side by side and both sold the exact same television only one charged 5.75% more to compensate the sales people in the store, at which would you buy your TV? The only reason to go load is because an investor wants a broker to pick their funds for them – the same reason a novice video equipment shopper might chose the higher priced electronics store – presumably the staff there could help pick out a TV that’s right for you (although there are other ways to get help in building an investment portfolio that don’t come with an intrinsic conflict of interest risk.)
2. There are more important decisions then whether the fund is load or not.
A retired investor living off income should not have all of their money in a biotech fund – this decision is more important then making sure the biotech fund is load or not. Low risk investors need to be in low-risk funds. But while we can’t argue with the basic premise of this point, why not choose a no-load low-risk fund over a loaded one?
The author’s idea is akin to saying the most important decision is not getting the best price on a new car, it’s if you wear your safety belt or not. True, but you can still buy a car and get the best price AND wear your safety belt. Wearing your safety belt is an easy and important decision you can make after you decide not to pay excessive fees.
3. If a load fund has a better performance record then a no load fund, you should go with the load fund.
This is even worse advice then recommending buying a no load fund simply because it has a better performance record then another no load fund regardless of fees. The assumption here is a good track record is worth paying for, even if it means paying a huge sales commission on top of already high annual fund fees. It is very difficult to consistently pick funds that will perform better than most other funds going forward. Raw past performance data really is no indication of future results, and is certainly no rationale for paying higher fees. Past performance is fleeting. Expenses are eternal.
4. Few load funds have identical no load twins.
The implication is if you find a good load fund you should buy it, as most load funds don’t have a no-load alternative. In the latest Value Line Mutual Fund Survey there are roughly 13,000 mutual funds. There are probably 3,700 more funds too small, new, or hidden for Value Line to track. While Value Line’s database represents multiple shares classes of the same underlying fund (A,B,C,D, I,Y,Z…) there are at least 6,500 distinct mutual funds out there – both load and no load.
There are maybe a dozen cases where an investor wouldn’t be able to find a comparable no load fund that does essentially the same thing as well as a load fund does. These few lone load funds with no loadless equal probably have an ETF or closed end fund equal or represent alternative strategies that would at best be small percentages of a portfolio. Often an investor can even find a no load funds run by the same manager who runs a load fund. Bottom line: few load funds don’t have a similar, less expensive, no load twin.
5. Over the long haul loads only add about .44% a year in extra expenses.
Maybe so, but .44% per year is still a great deal to give away over the long haul, especially if you don’t have to.
The reason index funds beat most actively managed mutual funds is because most fund manager’s stock picking skills don’t often make up for the extra 1.20% more a year in annual fees a typical actively managed stock fund charges over an index fund.
Adding an additional .44% in annual expenses onto the typical no load fund fee structure is only going to make it that much more difficult to perform well. Over any 10 year time frame a no load index fund beats more actively managed load funds then actively managed no load funds – there’s all the proof you need that the extra .44% in fees only hurts your odds of success.
Moreover, there are other reasons to avoid load funds (like you need more). One big one is if your time horizon is less then a decade. As the average holding period for a fund has dwindled down to just a couple of years, there is a good chance you are a relatively short-term investor. In such a scenario the extra cost over no load funds is far more then .44% per year.
Imagine buying a fund and paying a 5.75% front end load, and then finding out the manager leaves a few months later. Should you stick around 10 years with a new manger, or sell and lose up to 5.75% of your investment? A load may spread out to “just” .44% a year over a decade, but over a year or two it’s a killer. Since you bought the overpriced fund in the first place because of the great track record, sticking around after the manager leaves doesn’t make any sense
Load funds are for two types of investors: 1) clients of honest commission based brokers (there are probably one or two out there) and 2) wealthy investors who are rich enough to have the load fees waived (sadly some brokers have even kept their rich clients in the dark about the fee breakpoints). Everyone else doing their own fund picking should never buy a load fund.