“Do you get better mutual funds when you pay sales charges?”
It’s a great question that I’ve fielded many, many times throughout 20-plus years in the financial planning business. But it’s also a question for which I fear objective, truthful answers are hard to come by. So I’m going to fix that.
The answer is no. Mutual funds with sales charges (also called sales loads) don’t perform any better than those without that extra layer of expense. What’s worse, if you take a close look at the numbers, it’s pretty clear that paying sales charges actually makes it more difficult to get better results. Why? Because the extra expense reduces the return you would have otherwise earned.
So, with no empirical evidence that sales charges make mutual funds perform better, why would anybody pay them? From my perspective, the only reason you might want to pay them is if you’re getting something of value from the person selling you the funds. In other words, a better question might be: Does paying sales charges help you perform better? If not, or if you’re not getting additional financial assistance of some kind, I would argue that you shouldn’t pay sales loads at all.
You Better Get What You Pay For
But what about the old adage: “You get what you pay for?” Isn’t that true in the mutual fund world? Again, not if you’re just looking at mutual fund returns. You see, the basic truth of mutual fund sales charges is that they exist primarily to compensate the broker or advisor for selling the funds. Sales charges don’t get you access to better performing funds. They really just get you access to someone who sells those particular funds, whether the funds perform better or not. Remember, there is no proven positive relationship between sales charges and fund returns.
Does this mean that purchasing mutual funds from a commission-based broker or financial advisor and paying sales loads is a bad thing? Not necessarily.
I worked in that world for many years and always considered my recommendations to be ethical and in the best interest of my clients. I also have many friends in the industry that are similarly compensated, and they are terrific advisors. Again, the issue is not simply a question of the sales charges. It’s also about what you’re receiving in return for paying them.
Before initially agreeing to pay sales charges, you should evaluate that trade-off by assessing whether you think your advisor can deliver on what he or she is promising. Then, after seeing what type of service and advice you receive, you can decide whether it makes sense to continue down that path.
Fortunately, if you decide that paying sales charges isn’t right for you, other alternatives exist. You can go the no-load route with another broker instead and invest in funds that don’t have sales charges.
This doesn’t necessarily mean you’ll be flying solo and have to pick the funds yourself. There used to be a time when “no load” meant “no advice,” but that’s no longer the case. Today, several companies (USAA included) offer no-load mutual funds and will help you decide how to invest. In some cases, you can even get financial planning advice as part of the deal. No-cost help is available.
Keep in mind though, that all mutual funds (no-load included) have operating expenses which will negatively impact your returns each year. The fund prospectus will disclose the nature and amount of these expenses as well as what, if any, sales charges are present.
Don’t Just Accept It
To summarize, paying sales charges isn’t necessarily bad – as long as you’re getting something of equal or greater value in return. They could even help you (and your finances) perform better if they’re packaged with quality investment advice. One thing they won’t do though is get you better performing funds.
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