What it means
Many mutual funds sold through advisers carry a sales charge, which pays for advice and distribution. The charge is expressed as a percentage of the amount invested.
It does not go to the fund manager but to the selling firm and its adviser. There are several types, and the most familiar is the front-end load, which is deducted at purchase so that only part of your money is invested.
A back-end load, also called a contingent deferred sales charge, is paid when you sell and usually falls over time, reaching zero after several years. A level load is charged each year as part of the ongoing fees.
Share classes often reflect these structures. Class A shares typically carry a front-end load, Class B shares a back-end load, and Class C shares a level load with a short back-end charge.
No-load funds carry no sales charge, although they may have other costs such as annual management fees. Regulators set limits on how high sales charges can be, and many funds offer discounts, called breakpoints, for larger investments.
Investors who put in $100,000 or more may pay a lower rate than someone who invests $10,000. Asking about breakpoints can reduce the cost significantly.
The true cost of a sales charge comes from compounding. Because the charge reduces the money working for you from day one, a front-end load of 5% requires the investment to grow about 5.3% just to get back to your original amount.
Comparing total costs, including annual fees, helps you decide whether the advice is worth the charge. Many advisers have moved towards fee-based accounts, where the client pays an annual percentage for advice and buys funds without sales charges.
This can be cheaper or dearer than a one-off load, depending on how long the client stays invested and how much advice is used. Comparing both options over the planned holding period is the fairest test.
In practice
Real-world examples.
Example
A client invests $50,000 through an adviser in a Class A fund with a 4% front-end load. The charge of $2,000 is deducted, leaving $48,000 invested. The client's account statement shows the $48,000 from the first day.
Example
An investor buys a Class B fund with a back-end load of 5% in year one, falling by one percentage point each year. When she sells in year three the charge is 3%, so on a $20,000 holding she pays $600.
Example
A small business owner compares a no-load index fund with a loaded fund for his company retirement savings. He chooses the no-load fund because the difference in cost over 20 years would be thousands of dollars. He asks his accountant to confirm the fund meets the plan's rules.
Formula
Calculation
Sales charge = Amount invested x Sales charge percentage. Net amount invested = Amount invested - Sales charge.
Suppose you invest $10,000 in a fund with a 5.75% front-end sales charge. The charge is $10,000 x 0.0575 = $575, so $10,000 - $575 = $9,425 is actually invested. To get back to $10,000, the investment must grow by $575 / $9,425 = 0.0610, or about 6.1%. On a $100,000 investment at the same rate the charge would be $5,750, which is why breakpoints that reduce the rate for larger amounts are worth asking about.Case study
Seen in the real world.
Pinecrest Advisory is an entirely fictional financial planning firm. In this illustrative story, a client has $200,000 to invest and is offered a fund with a 5% front-end load by a salesperson.
The firm's planner points out that $200,000 qualifies for a breakpoint with a lower charge of 3.5% and that a similar fund with no sales charge is also available. She sets out the cost in dollars: $10,000 at 5%, $7,000 at 3.5% or nothing for the no-load alternative.
The client chooses the no-load option and pays the planner a separate advice fee. The illustrative lesson is that asking about sales charges, breakpoints and alternatives before investing can save thousands of dollars. A year later the client tells a friend that the clear dollar comparison was the most useful part of the meeting.
Watch out
Common mistakes.
- Thinking a no-load fund is free, when it may still charge annual fees.
- Ignoring breakpoints, when larger investments often get a reduced rate.
- Forgetting that a back-end load applies when you sell, which can lock you in for several years.
Questions
People also ask.
What is a front-end load?
It is a sales charge deducted from your money when you buy the fund.
What is the difference between a load and an expense ratio?
A load is a sales charge paid when buying or selling, while the expense ratio is an annual fee for running the fund.
Can I avoid a sales charge?
Yes, you can choose no-load funds, buy through platforms that waive it or negotiate a breakpoint discount.
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