What It Is:
How It Works/Example:
Back-end loads are expressed as a percentage, and they must be disclosed to potential investors in the security's prospectus. Let's look at an example.
Assume you invested $10,000 in the XYZ Company mutual fund, which has a 4% back-end load. After a certain time, the investment has grown to $12,000 and you are ready to sell. Of the $12,000 current value, $480 ($12,000 x .04) is paid to the fund company as a back-end load, and the investor walks away with $11,520.
Ideally, the earnings from such an investment should be high enough that, after the back-end load is paid, the investor still has a net gain. In this example, the investors gain is large enough that he still makes a profit after the back-end load is paid.
Back-end loads vary widely. Sometimes they can be applied to the reinvestments of dividends, interest, or capital gains. Frequently, investors are able to pay a reduced load if they own the investment for a long time. If so, the rate at which the fee declines will be stated in the prospectus.
Why It Matters:
Back-end loads are most often associated with mutual funds, but annuities, life insurance policies, and limited partnerships may have back-end loads as well. When mutual funds first became popular, most could be purchased only through brokers or financial advisors and they charged a front-load fee. As the number and popularity of mutual funds increased, "no-load" and "back-end-load" funds soon became the norm.
Loads discourage investors from frequent trading of mutual fund shares, an activity that would require funds to have considerable amounts of cash on hand rather than invested. Generally, however, a load is considered payment for the broker's expertise in selecting the right fund for the investor. Notably, there is considerable controversy about whether back-end load funds perform better or worse than other types of funds.
Back-end loads and other fees are disclosed in a mutual fund's prospectus, and it is important to understand that a back-end load is only one of several types of fees that may be charged. Thus, when comparing investments, investors should be careful to evaluate all fees associated with each investment, not just the size of the back-end load.