When investing in mutual funds, it’s important to understand the fees you’ll pay. A sales load is a commission fee that applies when you buy or sell shares of a mutual fund. There’s more than one type of sales load or sales charge you may pay, and the type of fee can determine how and when it’s calculated. Understanding load fees is important when deciding which funds to invest in, as these charges can impact your net investment returns.
A financial advisor can help you create a financial plan to maximize the efficiency of your portfolio.
Sales Load, Definition
A sales load or sales charge is a commission that you pay to an advisor or broker who sells you a mutual fund. Many mutual funds carry sales charges, which are often used to incentivize brokers to sell a particular fund.
The amount you pay for load fees can vary from fund to fund and may depend on the share class of the fund in question. When looking at a mutual fund’s prospectus or pricing guide, you may see sales loads expressed as a percentage. For example, you may see a fund that has a sales charge of 3% or 5%.
Sales loads are not the same as other fund costs, which are included in the expense ratio. The expense ratio represents the cost of owning a fund annually, expressed as a percentage of the assets. This amount is paid to the fund itself while a sales load is paid to the entity that you purchase the fund from. Mutual funds can charge both a sales load and an expense ratio. For example, you may own a mutual fund that has a 0.50% expense ratio and a 5% sales charge.
Types of Sales Loads
There are different types of sales charges that may apply when buying and selling mutual funds. The type of fee you pay depends on when it’s applied.
A front-end sales load is paid when you purchase shares of a mutual fund. This money is taken out of whatever you invest in the fund. So, if you were to put $10,000 into a mutual fund that charges a front-end sales load of 3%, $300 of that money would go toward covering the fee while the remaining $9,700 would be invested.
A back-end or deferred sales load fee is paid when you sell your shares of a mutual fund. So essentially, the fee comes out of your initial investment plus the earnings, assuming you’re selling the fund for more than what you paid for it. Typically, back-end sales loads are based on what you initially invested, rather than what you’re walking away with after the sale.
In some cases, it’s possible that a sales load could decrease over time. For example, the sales charge may decline year over year as you hold the investment, eventually reaching zero. Whether you pay a front-end sales load, a back-end sales load or a declining or sales load typically hinges on the share class of the fund you’re investing in.
How Sales Loads Are Calculated
Brokers that facilitate mutual fund transactions must follow certain guidelines for setting sales loads. Specifically, FINRA rules cap the maximum sales charge that can be applied at 8.5%. Sales loads can be set anywhere within that cap and again, whether a front- or back-end fee applies and the amount often depends on the fund’s share class. Class A share funds more often charge front-end sales loads while Class B share funds typically have back-end fees.
It’s possible, however, that a fund can charge both a front- and back-end sales load. The formula brokers use to calculate sales charges and what you’ll pay to invest can include:
- Net asset value (NAV) of a single fund share
- Front-end or back-end load amount
- What you initially paid per share
- How much you invested altogether initially
For mutual funds that charge front-end loads, the math is fairly simple when determining how much you’ll pay to invest in terms of the sales charge itself. Again, if you want to put $100,000 into a mutual fund with a 5% front-end load then that works out to $5,000 that comes right off the top of your initial investment.
With back-end sales loads, the calculation is the same but you aren’t paying it until you sell. What’s more important to understand is how a front-end vs. back-end sales load can affect your returns over time.
If you’re paying a front-end sales fee, then you’re investing less money right off the bat. Going back to the previous example of a $5,000 sales load, your starting point would be $95,000 instead of $100,000. It may not seem like a lot but you’d have to consider how that $5,000 difference might impact your overall return for the time frame in which you plan to invest. Even a difference of a few thousand dollars could cost you significantly if you’re missing out on the power of compounding interest on that money.
Consider No-Load Funds to Avoid Sales Charges
If you’d rather not deal with sales loads, there’s an alternative: choosing no-load mutual funds instead. These mutual funds don’t charge any type of sales load, either at the front-end or the back-end. That means you don’t have to worry about fees shrinking your initial investment upfront. But there are some other fees you may pay that can detract from your returns.
For example, you may pay a redemption fee to redeem your shares. The Securities and Exchange Commission caps these fees at 2%. No-load funds can also charge account maintenance fees, purchase fees and exchange fees if you decide to transfer to another fund within the same fund group. These fees aren’t technically loads but they’re worth noting when deciding where to invest.
Again, no-load fees still have expense ratios. The lower the expense ratio, the better for hanging on to more of your returns. When comparing expense ratios for different mutual funds, also consider the fund’s performance and return profile. It’s possible that a higher expense ratio may be justifiable if it’s accompanied by consistently strong returns over time.
Mutual fund sales loads can directly impact your investment gains over time so it’s important to understand how they’re calculated and when they’re applied. No-load mutual funds offer an alternative way to invest but they can also come with fees that it’s important to be aware of. Using a free tool like FINRA’s fund analyzer can help you compare costs to decide which funds are right for your portfolio.
Tips for Investing
- Try to avoid funds that charge 12b-1 fees, which are annual distribution fees related to mutual funds. They are an operational expense, and they’re usually a part of a fund’s expense ratio.
- Consider talking to a financial advisor about the basics of sales loads and investment fees. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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