Sales loads and other 12b1 fees just pay financial advisors to recommend more expensive mutual funds and ETFs
There is no good evidence that investment sales loads and other 12b-1 sales fees charged to investors result in higher mutual fund and ETF performance. In fact, the opposite has repeatedly been shown to be true.
Mutual funds have a long performance history to evaluate. Investment research shows that brokers and financial advisers do not pick better funds. Instead, they try to sell you the more expensive funds that they are paid to promote. By promoting more expensive funds, these higher fees actually reduce performance. Paying a load just means that you are throwing your hard-earned money down a hole.
Front-end and back-end loads, 12b-1 fees, and other sales compensation charges only ensure that an advisor and his/her advisory firm will be compensated for guiding you to select funds that will pay these fees. Front end sales loads reduce the amount that will be invested in the fund on your behalf. You will have less money invested and fewer assets upon which to earn a return.
Back end sales loads allow funds to take away a share of your future returns. Funds with front-end and back-end loads also tend to charge higher annual fees. Marketing fees sometimes known as 12b-1 fees are additional periodic sales charges that further reduce your ongoing returns. Assessed over time, 12b-1 fees pay a sales agent for periodic “servicing.”
Front end sales loads, back end sales load, and 12b1 charges pay advisers. They are not used to improve ETF and mutual fund investment performance.
There is zero connection between the management of the fund and the extra front end sales loads, back end sales loads, higher management expenses, and 12b-1 marketing fees that you pay, when you buy through a financial counselor. There is absolutely no reason to believe that the fund will perform any better to compensate for these charges.
Because securities markets are generally efficient, superior performance is largely due to luck rather than skill and superior performance tends not to persist. On average across funds, front end and back end sales loads are a dead weight loss to you due to market efficiency and the fact that the loads you pay are not even applied toward improving performance.
All a front-end sales load or back-end sales load will guarantee is that there will be a paid sales person to tell you that the fund that they are trying to get you to purchase is a “better” fund. While advisors will most often be careful to avoid making specific promises about future performance, they will not hesitate to provide materials that suggest that the fund has had superior past performance and perhaps a 4-star or 5-star Morningstar Rating.
This game is easy to play, because only those mutual funds and ETFs with past “superior” performance will be promoted by the commissioned financial advisor. Other less expensive and no load mutual funds will be conveniently ignored. When superior performance stops in the future, then new “better” funds will be promoted instead. Past “better” funds that do not turn out to be better will be shelved. The securities industry has been playing this superior investment performance shell game for decades. Unfortunately, you get stuck with mediocre future performance and higher investment costs.
When choosing stock and bond mutual funds, eliminate ALL front end and back end loaded mutual funds from consideration.
There are thousands of fine no-load funds available. Ignore the sales pressure of any financial counselor or investment advisor who pushes stock and bond mutual funds with loads, marketing charges, and higher expenses. You can buy noload mutual funds directly from no load mutual fund families. You can buy exchange traded funds through discount brokers and then hold them for a very long term to amortized your trading costs.
Note that certain very limited back-end loads can sometimes be beneficial to you, but only if they expire quickly and are designed to prevent costly active trading in and out of the fund by other investors who exploit buy and hold investors. Accept short duration back-end redemption fees that are unlikely to affect you (months and not years). Also, you should be reasonably certain that you can stay invested in the fund long enough for the redemption penalty period to expire.
Do not accept back end load charges. These back end charges should not be paid to an investment adviser or to the fund promoter. Instead, these back end charges should be in the form of a redemption fee that is paid only to the shareholders who remain in the mutual fund. Before buying, ensure that all redemption proceeds from early-exit investors will be returned the fund’s investment pool for the benefit of its longer-term shareholders.
Do not pay brokerage account wrap-fees that are charged by retail “full-service” stock brokers.
It is unnecessary to pay wrap fees to purchase good no load mutual funds and and low fee ETFs. Buy-and-hold individual investors do not have to pay high (or any) percent of assets wrap account fees to buy and hold mutual funds and ETFs. Buy them yourself directly and avoid wrap accounts that bleed your personal investment portfolio year after year after year.
If you have sufficient personal initiative to research low cost index mutual fund alternatives, then you can get a very large extra financial payoff by purchasing directly from the mutual fund. Investing directly in funds that you select yourself is very straightforward. It really does not take much time and your “hourly wage” for buying low cost index mutual funds and ETFs is huge.
All mutual fund families that allow direct investments have toll free customer service telephone numbers to request forms to be sent through the mail. Telephone representatives will tell you how to invest. No load funds dealing directly with the public also have easily downloadable and printable forms on their websites.
Filling out and mailing in these noload fund investment forms is only mildly tedious. However, when you do it yourself and you do not pay a commission to purchase through an investment advisor, you pay yourself a very high hourly wage for this relatively quick and painless process of purchasing directly from the mutual fund.
Exchange-traded funds are very easy to acquire, but just hold your ETFs and do not trade frequently.
Just use a discount broker to keep your transaction costs down. Furthermore, to amortize these brokerage transactions costs only buy broadly diversified, very low fee, index ETFs that you intend to hold for a long time. While somewhat different, ETFs and mutual funds share many similar characteristics.
However, one disturbing trend with ETFs has been the far more frequent trading of ETFs, which drives up your trading costs and your short term capital gains taxes and long term capital gains taxes unnecessarily. Do not get caught up on trading ETFs. Buy the broadest market index exchanged traded funds and just hold on to them. Do not trade. Brokers want to trade ETFs to drive up commissions. Just say no and sit tight. Passive buy and hold investors are far more likely to do better in the long run compared to active investors who chase the latest hot investment sector.
