What It Is:
How It Works/Example:
Let's assume you are interested in making a $10,000 investment in the XYZ Company mutual fund, which has a 4% front-end load. Of the $10,000 investment, $400 ($10,000 x .04) is paid to the fund company and $9,600 is actually invested in the fund as a result. Ideally, the earnings from the investment should more than make up for the front-end load. In this example, the front-end loaded fund must return 14.6% in one year to reach $11,000 in value, but the no-load fund must only return 10% to do so.
Front-end loads vary widely and may apply to reinvestments of dividends, interest, or capital gains. Frequently, investors are able to pay a reduced load if they make large investments. The amount that qualifies for a reduced load is called the breakpoint and varies from investment to investment. Some funds have more than one breakpoint. In some cases, an investor can sign a letter of intent with the investment company, promising to invest a certain amount over time in order to qualify for the reduced load now. Additionally, some investments provide for a right of accumulation, which grants a lower load when the investment reaches a certain level of investment over a certain time period.
When looking at mutual fund trading information, front-end loaded mutual funds will have ask prices that are greater than the fund's net asset value (or bid price). The ask price equals the fund's net asset value plus the front-end load.
Why It Matters:
Front-end loads are most often associated with mutual funds, but annuities, life insurance policies, and limited partnerships may have front-end loads. When mutual funds first became popular, most could be purchased only through brokers or financial advisors. 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 front-end load funds perform better or worse than other types of funds.
Front-end loads and other fees are disclosed in a mutual fund's prospectus, and it is important to understand that a front-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 front-end load. Additionally, the nature of the investment, the investor's risk tolerance, and the investor's time horizon should always be considered when evaluating any investment.