Imagine that a seller offers you a TV streaming service that offers exactly the same movies and TV series that Netflix offers, at the same monthly cost. The only difference: You have to pay a $100 entry fee to join.
It’s hard to imagine anyone accepting the competitor’s deal. However, many investors acted similarly for years by buying load mutual funds over no-load alternatives.
When the first modern mutual funds arrived in the 1920s, load funds were the only type of funds available. Investors paid a commission to a broker or other intermediary in order to invest. But these days, there are plenty of no-load alternatives to choose from. Furthermore, historical data does not show a substantial difference in performance between loaded and unloaded funds; in fact, Morningstar found that no-fee funds have a slightly better track record in recent years.
More and more investors realize that paying more for an investment does not mean that the investment is better. The latest evidence comes in the form of Charles Schwab’s announcement that he will stop selling mutual fund share classes that carry sales loads.
As The Wall Street Journal reported, Schwab will no longer offer loaded share classes to clients, although clients who already own shares in such funds can continue to hold them with Schwab. “It’s a low-volume business that no longer makes sense for us to run,” a company spokeswoman told The Journal. (1)
The numbers support Schwab’s assessment. According to the Investment Company Institute, a mutual fund trade group, investors earned more than $500 billion from loaded share classes between 2010 and 2014; during the same period, they invested $1.34 billion in no-charge classes. Many mutual fund firms offer some funds that would normally carry loads to retail investors with a waiver of load, making it even more illogical for investors to pay for something they can get for free. Schwab’s decision remains a sign of things to come in the mutual fund market.
This trend predates the Department of Labor’s new fiduciary rules, but requiring a broader swath of financial professionals to put clients’ financial well-being first will no doubt hasten the demise of load funds. Schwab has been outspoken that the new Labor rule was not the direct catalyst for his decision, but changing standards may contribute to similar decisions by other companies in the future.
Some mutual fund companies may also drop certain share classes, as more investors become savvy enough to avoid them. One company, Waddell & Reed, said in February that it would merge class A shares, which charge an up-front charge, into institutional stocks, which typically charge no charge and offer lower expense ratios. Other mutual funds are likely to continue to offer stocks that include loads, if only to benefit the few investors who don’t realize they could get a better deal elsewhere.
Fee-only financial advisors and other professionals who do not benefit from commissions on individual investment products have long steered their clients away from load funds. Mutual fund companies introduced back-end load and level-load funds in large part because some investors had begun to resist the idea of paying a commission up front, but the fact remains that there is no good reason to pay a broker 5 percent or more. to invest, no matter when you pay it.
If Schwab clients were still buying load fund shares in substantial amounts, you can be sure Schwab would be happy to continue offering them, at least in taxable accounts. Schwab’s decision to shut down its load fund business is a sign that far too many investors have picked up on the fact that load funds are bad business.
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1) The Wall Street Journal, “Charles Schwab to Stop Selling Load Mutual Funds”
