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The Advantage of No-Load Mutual Funds


Jack Piazza
Sensible Investment Strategies

One of the basic decisions that every mutual fund investor must make involves the issue of fund structure: whether to choose a load or a no-load fund. Advocates of each type give the following arguments: load funds are necessary to compensate for research and advice; no-load funds save you money by eliminating unneeded expenses.

Let's first review the different types of mutual fund structures. Load funds charge a commission while no-load funds are commission-free. In addition, the vast majority of all load funds charge annual distribution fees, known as 12b-1 fees, which are used to pay for promotional costs; these costs vary from 0.25% to 1% of annual asset value. Some no-load funds also charge 12b-1 fees, but no-load funds that do not charge 12b-1 fees are known as 100% no-load or true no-load.

The structure of  load funds can be (A) front-end, with the commission paid initially and varying from 3% to 6.25% of the investment; 12b-1 fees in front-end load funds are usually 0.25% or (B) back-end or contingent deferred sales charge, with the commission paid when the fund is sold and beginning at 5% of the value of the fund and declining 1% per year until zero after year five; 12b-1 fees in back-end load funds are usually 1% and convert to 0.25% after five years or (C) level load, with the commission paid initially and usually equal to 1% of the investment; 12b-1 fees in level load funds are 1% for as long as you own the fund.

Is there really that much of a worthwhile difference between load and no-load funds? An analogy to comparing mutual fund structures would be a one-hundred yard race. If the race competitors have equal ability, but one has a five to six yard head start, you obviously know who would win the contest. In fact, the one with the head start would only lose to a competitor with far superior ability. In the mutual fund illustrations below, assume all "competitors" have equal ability in order to accurately demonstrate the differences in performance.

Assuming a $10,000 investment with a conservative 9% annual net return rate -- after annual fund operating expenses of 1% -- over three years, the following illustrations compare the differences in cumulative total return and Return on Investment (ROI) among four different types of mutual fund structures:

  • 100 % no-load (no 12b-1 fee)
  • 5.75% front-end load with 0.25% per year 12b-1 fee
  • 3% back-end load with 1% per year 12b-1 fee (sale at end of year 3)
  • 1% level load with 1% per year 12b-1 fee


Fund Structure - Cumulative Return Comparison
  Start Year 1 Year 2 Year 3
100% No-Load $10,000 $10,900 $11,881 $12,950
5.75% Front-End Load (0.25% 12b-1 fee) $  9,425 $10,248 $11,142 $12,114
3% Back-End Load (1% 12b-1 fee) $10,000 $10,791 $11,645 $12,189
1% Level Load (1% 12b-1 fee) ** $  9,900 $10,683 $11,528 $12,440

Fund Structure Comparison - Cumulative Return of Investment
  Year 1 Year 2 Year 3
100% No-Load 9.0% 18.8% 29.5%
5.75% Front-End Load (0.25% 12b-1 fee) 2.5% 11.4% 21.1%
3% Back-End Load (1% 12b-1 fee) 7.9% 16.5% 21.9%
1% Level Load (1% 12b-1 fee) ** 6.8% 15.3% 24.4%

** Over longer time periods, the cumulative return of the 1% level load fund, due to its constant 1% annual 12b-1 fee, will be much less advantageous than either the front-end or back-end load funds.

In cumulative Return on Investment (ROI) after three years in this illustration, the 100% no-load fund outperforms the 5.75% front-end load fund by 39.8%, the back-end load fund by 34.7% and the level load fund by 16.8% -- even though the annual return rate is identical for all four funds.

The ROI advantage of the 100% 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% no-load fund in these illustrations is very apparent. Comparative ROI differences would be even more dramatic as the annual return rate parameter falls below 9%, less dramatic as the annual return rate parameter rises above 9%.

Does this imply that all no-load funds are superior to all load funds? Of course not. Obviously, a 5.75% front-end load fund with a 15% annual return will outperform a no-load fund with a 9% annual return. However, no-load funds that carry above average rankings from Morningstar will most likely outperform load funds, provided that the funds are in the identical fund category (i.e.; large growth, large value, mid blend, small growth, etc.) with a time frame of at least three years.

Finally, you should be aware of asset-based fees. Within the last few years, many major brokerage and advisory firms have announced that they will offer no-load funds from many fund families without charging commissions or even 12b-1 fees. However, these firms will compensate salesmen by charging clients, in some cases, up to 2.0% of their assets on an annual basis. Over a relatively short time, these fees would be substantially greater than even a 5% front-end load! It is best to avoid these types of fees and maintain the no-load advantage.