NEWS AND RESOURCES

Financial Planning for June 2003

Are Your Funds Loaded?
There have been many debates down through the ages. Questions like "What came first, the chicken or the egg," "Whatís the meaning of life," "Who shot J.R.," and similar issues have perplexed mankind for eons. Unfortunately, we canít deal with all of these issues in this short article, but we can deal with one of the single most frustrating issues involving investorkind, "What is better, the load or no-load fund?"

In order to answer this weighty question, we must first understand what we mean when we use the term "load". For all intents and purposes, a "load" is the same thing as a sales commission to the person selling the fund. There are a variety of ways that funds may charge commissions or marketing fees. These are generally categorized as:

No-load, which means what it says. The fund does not charge sales commissions on the front or back end. However, some no-load funds charge 12b-1 fees. These are fees that a fund pays for "marketing" and distribution costs. If the fund you are looking at seems to be a no-load fund, dig deeper and find out if the 12b-1 fees are being charged. If the percent fee being charged is around .25%, this is basically a 100% no-load fund as your advisor or broker receives nothing on the sale. However, if the fees are greater than .25%, say 1%, then your advisor is probably being paid something on the sale and this isnít a 100% no-load fund.

Thatís ok. I mean, when was the last time you offered your services or product for free - and stayed in business?

Back-end load, or deferred sales charge, funds are those that charge you nothing when you invest, but when you sell, you pay for the free ride. Generally, the deferred sales charge goes down over time. For example, if you bought XYZ Growth Fund, the sales charge may be 5% if you sell within a year, 4% if you hold the investment between one and two years, and continue to decline until the charge disappears totally. Some funds may have a straight charge when you sell regardless of how long you hold the fund.

These funds can charge 12b-1 fees also, so you may not really get a free ride up front.

Level load funds are those that charge a flat percentage up front and every year thereafter, generally 1%.

Front-end load funds are those that charge a commission (anywhere from 3%-6.25%) when you invest. Be careful, though. Just because the fund charges up front does not mean you wonít have any 12b-1 fees in your future. The obvious disadvantage to this type fund is you immediately lose some portion of your investment on day one, regardless of market conditions. While this loss is supposed to be made up because of superior performance of the fund in the future, the realities may be somewhat different.

Now that you know the terminology, what is the best fund for you? The short answer is - we donít know. Why? Because each investor is different in tolerances and goals. Until we know that, we wouldnít presume to give advice. There are a few generalities we have gleaned from reviewing the literature.

The first generality is that there are great front-end load funds that outperform no-load funds and there are great no-load funds that outperform front-end load funds. The point being that you will have to look deeply at each fundís performance rather than just whether it carries a load or not.

The second generality is the higher the load, the lower the performance over the long-term. However, as your time horizon gets longer, the closer the funds come in terms of performance. Letís take an example from the Yahoo! Finance Web Page. We wonít reproduce all the numbers here, but Yahoo prepared a comparison of a 100% no-load fund, a fund with a 5% front-end load plus .5% per year in 12b-1 fees and a fund with a 3% back-end fee and .5% per year in 12b-1 fees.

Fees were assumed to be the only differences in the funds. Therefore, the investment yields excluding fee considerations were the same as were other expenses. The results were interesting:

Year 1 - The 100% no-load fund had the highest return at 9%, followed closely by the back-end load fund at 8.4% with the front in load coming in at a dismal 3%.

Year 2 - The results were pretty much as expected and in line with the Year 1 results.

Year 3 - Year 3 tells the tale from a mathematical standpoint. By this time, earnings are sufficient to close the gap between the three funds. The most dramatic comparison is between the 100% no-load fund and front-end load fund. In Year 1, the 100% no-load fundís earnings were almost 3 times the earnings of the front-end load fund, but by Year 3, the 100% no-load fundís earnings were only 39% greater than the front-end load fundís earnings. By the way, these rates are cumulative and not annual returns.

What this says is that the 100% no-load fundís do better than the load funds. There, are you convinced? Do you promise not to buy any more funds carrying loads?

We certainly hope you are neither convinced that 100% no-load funds are always the best option and you better not make any promises based purely on this example.

As we said, there are many more things to consider than just the fee structure of the fund. For example, in some studies, small specialty funds with front-end loads have outperformed their "less expensive" no-load brethren. You also have to consider the volatility of a fundís assets (i.e. is the fund invested in a particularly risky industry?). Then thereís the focus of the fund. Is it a balanced fund, growth fund, income fund, etc.? Does the fund that looks good invest heavily in companies that are big polluters? If youíre the president of your local Sierra Club chapter, you may want to avoid it even if it is a no-load fund that makes a bundle.

The simple fact is there are literally thousands of mutual funds in existence and probably as many ways for the fund managers and sales force to be compensated. Ok, not thousands of ways to be compensated, but certainly there are a number of different compensation schemes. Before you invest your hard earned cash, doesnít it make sense to talk with professionals? Do some preliminary homework and then give us a call. We will help you focus on what is truly important to you and that may not be just the numbers.

Have a great June.

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