No-Load vs. Loaded Mutual Funds – Unfair Advantage

Paul Merriman at FundAdvice.com has been telling investors to “just say no” to buying mutual funds with a sales load for a long time. In his article “Loading up” on Poor Performance Merriman responds to an unhappy financial planner who tries to take him to task for steering people away from loaded mutual funds.

In Merriman’s response to the financial planner there were two quotes that explain the disadvantage loaded funds must overcome to meet or beat the no-load funds.

Imagine for a moment that you and I are portfolio managers – you at the load fund and I at the no-load fund. Suppose you know I will achieve a 10 percent return that first year and you’re trying to compete with me. To do that, your performance will you’ll have to be sufficient to turn $9,425 ($10,000 minus the load) into $11,000 in one year. That means you need a portfolio return of 16.7 percent. The only way you can hope to achieve that is by taking significantly more risk than if you were targeting a return of 10 percent.

This puts you in a pretty awkward position. Because of the load, you as portfolio manager must either settle for a much lower real-life return to your shareholders or you must take higher risks with your shareholders’ money.

But this short quote graphically demonstrates the handicap a load places on a mutual fund:

Load funds stack the odds against investors — like betting on a horse that must start far back in the pack.

Speaking of betting, I hope to write a post shortly about the common practice of always betting on the lead horse in the mutual fund race.