What is Load?
As one would expect, there are a few fees and commissions involved while dealing in any financial instrument, the most popular ones being stocks and mutual funds. These may include fees for the professional management and operations of the instrument, expert advisory fees, commissions to brokers, sales fees for trading (buying or selling shares), etc. Collectively, all such charges may be known as ‘load’. Especially in the case of mutual funds, the sales charges incurred for the trading of shares are termed as load.
With this information, it gets easy to understand the different types of mutual funds as categorized by the load. These may include ‘load funds’ and ‘no-load funds’. The ‘load funds’ can be further divided into front-end load funds, back-end load funds, and level load funds. There is also a category called ‘load waived funds’. In this blog, we shall further examine the front-end load mutual funds and what they may entail.
Front End Load Meaning
To simplify the meaning of front-end load, one can state that it is the upfront fees paid for purchasing that particular investment tool. A front-end load is most common in the case of mutual funds. However, it can also be applicable in the case of insurance policies or annuities (usually in the form of pension schemes). Let us take the example of front-end load mutual funds for ease of explanation. If you choose to invest $1000 in a particular mutual fund with a front-end load of 5%, then it implies that $50 (1000 x 0.05) goes to the fund house or fund company. The remaining $950 is what is actually invested and you will get the units worth this amount at the existing net asset value.
As you can see, the front-end load diminishes the overall investment value due to the deduction at the time of investment. Therefore, the fund needs to provide better returns to offset this deduction as compared to a no-load fund, wherein such a deduction does not take place and the entire amount is used in the investment.
Front End Load Further Explained
There are 3 main types of mutual fund shares, namely ‘A shares’, ‘B shares’, and ‘C shares’. Those shares which come with a front-end load fee structure are known as ‘A shares’. As mentioned in the previous section, in this case, a certain percentage of the original investment is deducted as upfront commission which tends to lower the final investment value. This load may vary across different mutual funds and there is no fixed absolute value. Hence, it is advisable to understand the front-end load percentage before investing.
To understand the origins of front-end load mutual funds, one needs to go back to the time when mutual funds and similar investment tools were newly introduced in the market. During that time, it was only possible to invest in the tools through a broker or a financial advisor/licenses consultant. To compensate these middlemen for the services provided, front-end load was introduced as a sales charge. In the present scenario, with a plethora of direct online modes to invest in mutual funds, no-load funds and back-end funds have become more prevalent and popular. Especially the no-load funds, since there is no upfront deduction from the original investment.
Should You Choose To Invest In Front End Load Mutual Funds?
Like most similar questions regarding different kinds of funds, there is no fixed or standard answer here. However, let us try to explore the pros and cons of the front-end load mutual funds to ascertain if the benefits outweigh the disadvantages.
Due to the upfront load, these types of funds typically come with a lower expense ratio (ER). This ER is basically the administrative and operating charges over and above any kind of load. Lower ER leads to a lesser reduction in your overall returns. Another advantage is that most front-end load mutual funds forgo or discount the annual maintenance charges, especially in the case of large or long-term investments. This, again, helps in building your cumulative fund value with the principle of compounded interest applied over it.
On the flip side, there is the obvious disadvantage of having your investment value reduced at the onset. Moreover, these funds tend to provide the best results when invested in the long term. Hence, people seeking short-term returns may wish to stay away since the fund would have to perform unrealistically well to offset your earlier deductions with accelerated returns.
As is the case with any kind of mutual fund or other investment instruments, careful research and due diligence are powerful and beneficial tools. Apart from the several online advisory portals, the mutual fund prospectus is a good place to start. This will help you understand the front-end load percentage, expense ratio, and historical returns of the fund. It is using these 3 parameters that you can guesstimate the benefit or pitfall in investing in that particular kind of front-end load mutual fund. Of course, there are other parameters worth considering such as your investment horizon, risk appetite, etc. As mentioned earlier, front-end load mutual funds may not be as effective in shorter investment periods.
Do note, that apart from the front-end load, there may be additional charges levied on your investment and returns. It is only after careful research and predictive calculation that you should consider investing in this or any other form of a mutual fund.