The whole month, I’ve been learning about stocks, futures, options, leases, warrants, the whole schmeer. However, my book has nothing about “no-load” funds.
The impetus of my post? My bank sent me an ad today to invest in their “no-load” funds.
I assume this is some sort of mutual fund looking at the advertisement. It says something that:
. . . and so forth.
What is the mechanism behind this “no-load” fund thing?
Tripler
I’m curious, 'cause I can’t see how an investment doesn’t give a commission to someone somewhere. :dubious:
A front-load fund charges you money when you initially invest. A back-load fund charges you money when you sell. A no-load fund has none of those fees.
All funds (loaded and no-load) have administrative costs which pay the manager’s salary and other expenses that are deducted during the course of the year.
As a followup to zev’s excellent post, pay attention to the administrative costs. The lowest I’ve ever seen was .18% of the funds being managed… that was for an Index fund, which essentially requires as close to zero attention as possible from the investment house.
There are much, much, much higher rates. When you calculate your anticipated ROI, make sure you factor all this in.
So, zev, obviously there are administrative costs in no-load funds. If they aren’t charging me fees, what do they do, skim a percentage off of the return as their salary?
Tripler
If it claims a 5% return, do I really get, like 4.75%?
A mutual fund’s stated “return” will be net of their administrative costs, including 12b-1 fees; but not load fees.
For the past 20 years I’ve invested in only no-load mutual funds, following the advice and information provided in the No Load Fund Invester newsletter.
My investments have increased 10 fold in those 20 years (actually got to about 15 times the original investment, but the last few years have been brutal). Full disclosure: I continued to invest additional money during this time so the result is not totally due to magnificent returns.
Your OP was covered by Zev’s posts, but I thought I’d give you a link to some information.
Keep in mind that all returns stated are net of expenses. Zev covered this, but it is an important point. Therefore, if a fund claimed a 5% return you would have made exactly 5%. If the expenses of that same fund were 1% you would have made 6% without the expense charges.
The bottom line is that all funds have fees. Index funds are the cheapest and it goes up from there.
Sometimes. The sales literature from a mutual fund company states returns net of a front-end load (if any) or a back end load for whatever time period is being quoted (back-end loads tend to decrease over time as 12b-1 fees mount up). This is an NASD requirement.
However, the returns that appear in newspapers generally don’t include the loads and the mutual fund surveys that appear in many financial magazines are all over the place – some include the load, some don’t.
Finally, many mutual funds have multiple “classes” of shares. “A” share might have a front-end load and be intended for brokerages, “B” share might have a back end load for the same reason, “C” shares might simply have a 12b-1 component for so-called “wrap” accounts (where a financial advisor works for a percentage of assets under management rather than transaction fees), etc.
Basically, a distribution fee. Usually paid to the brokerage firm, financial adviser, etc. who sold you the fund, but sometimes to pay advertising expenses.
There are a bunch of separate fees that go into the total fees for a mutual fund.
Management fee: This is to compensate the advisor of the fund for managing the fund. It also usually covers accounting, legal work, etc. (full disclosure: Specifically, it compensates me. I manage a mutual fund).
Transfer Agent fee: This goes to the fund’s transfer agent – the company that does the tracking of how many shares you own, the price, reinvesting your dividends, etc. Not infrequently, the transfer agent is an affiliate of the management company, but sometimes it’s an independent company.
Custodial fee: This goes to a large bank which actually holds the assets – management companies can’t hold the actual assets of the fund with an affiliate (ususally) as a protection against the company running away with the money. So they pay a bank to do it. This fee is typically pretty small as a percentage of assets.
12b-1 fee: As discussed, this usually goes to whoever sold you the fund as compensation. Sometimes it can go to advertising the fund, but the rules under which the fee can go to that purpose are so convoluted that most fund complexes don’t bother.
Direct fees: Sometimes rather than include it in the management or transfer agent fees, a fund will pay directly for things like printing and mailing prospectuses and annual reports.
You might have some fun wandering around the site of the mutual fund industry’s trade group, The Investment Company Institute. Just keep in mind that they are a trade group, so their view is biased in their own direction.
A further question: When and why would you particularly want to invest in this sort of thing, versus say, a common stock or bond? Is the risk that much lower? The return about the same as some other investments? Do they hedge your portfolio against some drastic up/downswings?
What’s your thinking?
Tripler
Am I thinking about investing in them? You guys teach me what kinda tools these are, and I’ll think about it. . .
The risk is generally lower with a mutual fund because of diversification. For a little extra money, you get yourself invested in all the stocks that the fund holds without doing a lot of work. You could buy all the shares that the fund holds yourself, but that’s a pain in the ass. You are paying someone to do that for you.
For a regular (non-index) mutual fund, you are also paying for the expertise of the fund manager, who will choose which stocks to buy and sell with the fund’s assets. Each fund is different. Some invest in a few high-risk sstartups, some invest in rock-solid blue-chips, and some are index funds. You can buy shares in the fund directly from the fund company, or from your stock broker if it is a publically traded fund.
Index funds are funds which simply buy whatever is in the common stock market indexes, such as the S&P 500 or Dow Jones. They have the advantage of getting you invested in a large number of very reputable companies and have very low fees because they require almost no actual management. Whatever the index did on a particular day, you know that your index fund did the exact same thing. Because the stock market as a whole always grows over the long term, and because indexes are created to be representative of the whole market (or a market sector) index funds are a fantastic long-term investment. I highly reccomend index funds.
It’s actually not that much lower for most actively-managed mutual funds. Here’s what Dr. John Cochrane of the Graduate School of Business at the University of Chicago says about this (pg. 49):
Thanks manhattan for the correction to my statement that load fees were not taken into consideration in the published returns. You can correctly conclude from my error that I don’t spend much time looking at load funds.
Tripler, in addition to friedo’s excellent explanation of why to buy mutual funds instead of individual stocks/bonds is that it is near impossible to research and purchase non-US stocks and bonds. Any well diversified portfolio should include international funds.
Just to add to what friedo posted, there are a couple of other advantages of index funds over managed mutual funds (load or not).
First, index funds tend to be easier on your pocketbook at income tax time. In a managed mutual fund, the fund manager may frequently buy and sell equities in pursuit of the holy grail of higher returns. In the process, the mutual fund will spin off a lot of capital gain distributions, on which you’ll have to pay income tax.
An index fund, because it’s simply buying and holding all of the stocks in a given index, is less likely to generate similar tax liabilities. That’s not to say an index fund won’t spin off cap gain distributions - it will, if the stocks that make up the index change, or if the fund manager (more likely, a software program that someone watches over!) has to sell some of the portfolio in order to bring the balance among the index fund’s holdings in line with the index in question. But an index fund will generally generate far fewer cap gain distributions.
The other problem with managed mutual funds is that, in any given year, only about 20% of all mutual funds manage to out-perform their corresponding indexes. That’s fine, if the fund you bought is in that 20%. It gets messy in year two, however, since that year, 20% of the managed funds will again outperform the index, but it won’t be the same 20%, necessarily.
So, every year, you’re faced with trying to predict which brilliant fund manager will make the inspired stock choices that will let him or her outperform the market.
Some funds do very well for a few years, then tank. Other funds may lag the market for a while, then hit a few home runs. Figuring out which is which can be pretty daunting.
Good answers so far–the only thing I want to do is to say something very basic.
Yes, every fund has expenses, but “load” means a sales commission. Front-end and back-end loads simply mean you pay a percentage of the purchase price to the broker who sells the product. There is no reason to pay a load if you can identify the fund that suits you and call the fund’s 800 number. In other words, as others have said, this is an optional expense.
The other expenses, such as the trading commissions the fund must pay when it buys and sells shares, the administrative overhead fees, the transfer agent and custodian fees, are, for the most part, not optional, and are usually substantially less on a percentage basis than any load would be. Therefore, while some funds are more thrifty than others (and, as mentioned, index funds are typically the thriftiest), the big gap is between load and no-load funds; the differences between funds with respect to other expenses are less pronounced.
Mutual funds provide ready-made diversification–a small investor might not have enough money to buy even one share of each company in the S&P 500, not to mention that the transaction costs would eat him up.
