How Do No Load Funds Make Money

What is a No-Load Fund?

A no-load fund is a type of mutual fund where shares are bought and sold without commission charges for the purchase or the sale being taken out of the investor's funds. The sales charges are called the "load," and no-load mutual funds, as the name would imply, offer investors a fund option without such fees.

No-Load Fund

Wise investors know how impactful fees can be to overall returns. Even a few additional basis points in fees can reduce overall return by thousands and even millions depending on the size of a portfolio.

One way to minimize the fees you pay by investing in mutual funds is to opt for a no-load fund. However, the absence of commission charges will need to be weighed with other factors in mind, such as a fund's overall expense ratio Expense Ratio An expense ratio is a fee charged by an investment company to manage the shareholders' funds. Investment companies such as mutual funds often incur various operating expenses when managing investors' funds, and they charge a small percentage on the funds under management to cover the expenses. , the fund's performance history, investment style, risk tolerance, etc.

Mutual funds will disclose whether or not the fund charges loads in their prospectus Prospectus A prospectus is a legal disclosure document that companies are required to file with the Securities and Exchange Commission (SEC). The document provides information about the company, its management team, recent financial performance, and other related information that investors would like to know. .

Summary

A "load" is a charge by a mutual fund for the buying and selling of shares that are allocated to an intermediary such as a broker, advisor, or another type of professional.
A no-load fund is a fund that does not charge a sales load fee.
No-load funds are purchased directly through the investment company and do not require an intermediary to act as a broker.

What is a Load Mutual Fund?

The counterpart to a no-load fund is a load fund. The mutual fund loads charge investors when buying or selling shares. The load charges can be within the range of 0% to 6%. When loads are charged upon purchasing shares, it is known as a front-end load. When loads are charged upon the selling of shares, it is referred to as a back-end sales loads.

So why are sales loads charged? The charges are meant to compensate an intermediary, such as a broker, financial advisor, and other professionals, for selecting and recommending the appropriate fund for the investor. The rationality is that the intermediary has put in the time and dedicated their expertise to sift through funds and find the one that best fits the investor's needs. It is controversial because history shows that load funds and no-load funds nearly have the same performance.

Why Choose a No-Load Fund?

When an investor chooses to invest in a no-load mutual fund, they are bypassing the load fees. It is possible because a no-load fund will be without an intermediary that is looking to collect commissions. A no-load fund is usually purchased directly from the investment company offering the fund.

Since there is no professional expertise being used to recommend the fund, it is the job of the investor to make their own decisions. Many investors are willing to do their own research and due diligence to save on the 4.5% that could've been charged with a load-fund. Without the fees, an investment in a no-load fund is free to grow upon investment and be untouched upon selling.

Examples of No-Load vs. Load Investments

No-Load

An investor purchases $10,000 of shares in a no-load fund and earns a 10% return over one year. The investor earns $11,000 at the end of one year and takes home a $1,000 gain.

Front-End Load

Let's say an investor purchases the same $10,000 worth of shares, but this time, it is in a mutual fund that charges a front-end load of 4%. The 4%, or $400, is taken out when shares are purchased, leaving $9,600 left to work. The fund provides a 10% return over the year, and the investor earns $10,560 at the end of one year.

Back-End Load

An investor purchases $10,000 of shares in a mutual fund with a back-end load. The fund earns a 10% return over the year for an ending amount of $11,000. When the investor sells his shares, the back-end load of 4% is charged on the $11,000.

The result is that 4%, or $440, is taken out of the investor's funds for a final balance of $10,560 and a take-home of $560. Instead of a 10% return, the investor realized a real return of 5.6%.

Why Choose a Load Fund?

With the math shown on the three scenarios above, you can see how impactful sales load charges can be on a portfolio's actual return. An investor will need to determine if the fees are justified.

Investors may choose to invest with a load fund for reasons, including:

Belief in the expertise of the professional they are working with to act as an intermediary.
The perceived benefits outweigh the costs of the load.
The investor may not want to research funds on their own. They would rather get a professional choose for them.
The investor maintains a relationship with their financial advisor Financial Advisor A Financial Advisor is a finance professional who provides consulting and advice about an individual's or entity's finances. Financial advisors can help individuals and companies reach their financial goals sooner by providing their clients with strategies and ways to create more wealth or investment professional and would feel guilty if they went about investments on their own without their advisor getting a commission.

Fees a No-Load Fund Can Charge

Just because a mutual fund doesn't charge fees for the purchasing and selling of shares does not mean that the fund is automatically a "low-fee" fund. It is possible that a no-load fund can end up being more expensive than a fund with a sales load charge.

Charges and fees included in a no-load fund can include:

The fund's expense ratio
12b-1 fees for marketing, distribution, and service
Redemption fees
Exchange fees
Account fees

One important thing to note is that no-load mutual funds may still charge fees when buying and selling shares. When you look at the definition closely, a load charge is a fee that is allocated to an intermediary who acted as a broker between the fund and the investor. A fund may charge fees to the investor when buying or selling shares, and the fees will go to the fund itself, not a broker. Thus, a fund of such type will still qualify as no-load.

Investors will need to consider all fees when analyzing multiple mutual funds. Looking at load vs. no-load is a good start but does not tell the whole story. Other fees may make a no-load fund more expensive than a load fund.

Additional Resources

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Commission Commission Commission refers to the compensation paid to an employee after completing a task, which is, often, selling a certain number of products or services
Management Expense Ratio (MER) Management Expense Ratio (MER) The management expense ratio (MER) – also referred to simply as the expense ratio – is the fee that must be paid by shareholders of a mutual fund or exchange-traded fund (ETF). The MER goes toward the total expenses used to run such funds.
Open-end vs. Closed-end Mutual Funds Open-end vs Closed-end Mutual Funds Many investors consider open-end vs. closed-end mutual funds similar due to both mutual funds allowing them a low-cost way to pool capital together and
Transaction Costs Transaction Costs Transaction costs are costs incurred that don't accrue to any participant of the transaction. They are sunk costs resulting from economic trade in a market. In economics, the theory of transaction costs is based on the assumption that people are influenced by competitive self-interest.