Why You Should Never Buy a Front-End Loaded Mutual Fund

By Marc Smith

Mutual funds that contain front-end loads are one of the worst investments for individual investors. In a typical front-end load fund, the investor pays a 5.75% commission just for the privilege of buying into the mutual fund. What most people don’t realize, however, is that commission is largely paid to your investment advisor. Mutual fund companies use front-end fees as a sales incentive to get advisors to direct client assets into their funds. In a standard agreement, you as the client would pay 5.75% in a fee and your advisor would get almost 90% of that fee. For example, if you invest $10,000 into a mutual fund, the front-end fee would be $575 (5.75% of $10k) and your investment advisor would be paid $500 (5% of $10k) of that commission for sending your money to that fund.

There is no evidence that front-end load funds perform better than lower fee funds. In fact, logic would tell you that smaller, less successful funds employ front-end loads because they have been unsuccessful attracting assets in other ways, implying their performance could be worse. Additionally, when you see your personalized performance it won’t be based off your $10k investment, it will be based off the amount you invested AFTER paying the sales commission. Performance numbers are always inflated because they don’t account for that fact you started down 5.75% from day 1 due to the front-end load. If you invest the same $10k, your statement will show $9,425 as your cost basis. Meaning, if the value rises to $9,700, your advisor will tell you are up 3%, when in reality, you are still $300 in the hole from the $10k you invested.

In my own practice, I don’t use any equity mutual funds and instead focus on individual stocks that I can understand and make a conscience decision to either buy or sell. The relative value of individual stocks versus mutual funds is a separate topic, but if you’ve made the choice to use mutual funds in your investment strategy, make sure your advisor knows that you do not want any front-end load funds. In fact, if your advisor is recommending front-end load funds, I think it’s time to find a new advisor. Many advisors have developed very effective methods to slip a few front-end funds into your account, convincing you of the relative value of said fund. In reality, there is no reason for an advisor to recommend a front-end fund other than wanting to earn the sales commission.

If you want further information or have any questions/comments, you can reach me at marc@redwaveinvestments.com.