Sales Load

A sales load is a charge levied on the purchase or redemption of mutual fund shares that compensates the distribution of the fund rather than the running of it. The Securities and Exchange Commission's investor education defines it as "a fee investors pay when they buy (front-end sales load) or redeem (back-end sales load) shares in a mutual fund, similar to a commission," and notes in the same entry that "sales charge," "sales load" and "load" are three names for the same thing. The statutory term is the middle one.

The definition in the Investment Company Act of 1940 is more useful than the plain-language one, because it describes the charge structurally instead of by its purpose. Section 2(a)(35) defines a sales load as "the difference between the price of a security to the public and that portion of the proceeds from its sale which is received and invested or held for investment by the issuer," less amounts deducted for trustee or custodian fees, insurance premiums, issue taxes, or administrative expenses not properly chargeable to sales or promotional activities. Read that once and the charge stops being abstract: a sales load is the part of your payment that does not become your investment.

Defining the load as a gap rather than a fee changes the arithmetic you should do. A load quoted as a percentage is conventionally a percentage of the amount you hand over, not of the amount that gets invested. So a charge described as 5.75% removes 5.75% of your money and invests the remaining 94.25%, and recovering your original outlay requires the smaller balance to grow by more than 5.75%. The gap is small at small percentages and grows noticeably at the levels loads have historically reached. This is not a criticism of the charge; it is a property of taking a percentage off the top, and it is invisible if the load is thought of as a fee added on rather than as a slice removed.

The two shapes differ in when they bite and in how they interact with your holding period. A front-end load is deducted at purchase, so the cost is known, immediate and final, and the position begins below what you paid. A back-end load is deducted at redemption, so nothing is visibly lost at purchase, and the charge is commonly structured to decline over a period of years and eventually reach zero. The SEC adds a detail worth knowing before redeeming: a back-end load is typically calculated on the lesser of the value of the initial investment or the value of the investment at redemption, so a position that has grown is generally charged against the smaller original figure. Either way, the effective cost of a back-end load depends on a decision you have not made yet, which is a difference in kind rather than in timing. Each of those two has its own page on this site; what matters here is that both are sales loads and both are one-time charges rather than annual ones.

The comparison that actually decides cost is with the expense ratio, and the two move in opposite directions with time. A load is a fixed amount surrendered once, so spread across a longer holding period its effect on the annual return falls. An expense ratio is charged on the balance every year, so its total effect rises the longer you hold. A fund carrying a load and a low expense ratio and a fund carrying no load and a higher one can therefore swap places depending on whether the money is held for three years or thirty. Any comparison that uses only one of the two numbers is answering a question nobody asked.

Where the money goes is a plain matter of fact and worth stating. A sales load is a distribution charge. It compensates the broker, advisor or other intermediary who sold the fund, which is why the SEC's own description reaches for the word commission. It does not pay for managing the portfolio, and it does not go to the fund. This is the reason funds are often offered in several share classes carrying different combinations of front-end load, back-end load and ongoing distribution fees, with the same portfolio inside each one. The charge relates to how you bought the fund, not to what the fund does.

Two related charges are not sales loads and are frequently mistaken for them. A redemption fee is charged by some funds when you sell shares back to the fund, and the SEC's own entry draws the line by recipient: the redemption fee is paid to the fund, while a back-end sales load is typically used to compensate a broker. So a fund charging a redemption fee can still be described as no-load. And a contingent deferred sales charge on an annuity or a cash-value life insurance policy works on a similar declining schedule but sits inside an insurance contract with its own rules; that charge has its own page.

You place an order for a fund whose share class carries a front-end load. The charge is deducted from your payment and the remainder buys shares at net asset value. The prospectus fee table states the maximum, and funds sometimes offer discounts at stated investment amounts, called breakpoints, so a larger purchase can carry a lower percentage. With a back-end load nothing is deducted at purchase; a charge applies instead if you redeem within a stated number of years, usually on a schedule that steps down annually.

A hypothetical example of why the quoted percentage understates the hurdle. Marcus invests $10,000 in a share class with a 5.75% front-end load. The load is $575 (5.75% of $10,000), and the amount actually invested is $9,425 ($10,000 − $575).

For his position to be worth the $10,000 he paid, that $9,425 has to grow by $575, which is a gain of about 6.10% ($575 ÷ $9,425), not 5.75%. The difference between those two numbers is small in absolute terms and it is the whole reason to think of the load as a slice removed rather than a fee added: a percentage taken off the top always requires a larger percentage to recover.

Had the same $10,000 gone into a share class with no load and an expense ratio higher by 0.25% a year, the annual cost on a roughly $10,000 balance would be about $25, and the arithmetic of which is cheaper turns entirely on how many years the money stays invested.

Pros

• The cost is disclosed as a stated maximum in the fee table and is knowable before you buy, unlike the return.
• It is charged once rather than annually, so on a long holding period its effect on the annual return diminishes.
• Funds commonly offer sales charge discounts at stated investment levels, called breakpoints, so a larger purchase can carry a lower percentage.
• It pays for a distribution relationship, which has value for an investor who wants one and is buying the fund through it.

Cons

• The money removed never gets invested, so the position starts below what was paid and needs a larger percentage gain to recover than the load percentage suggests.
• It is entirely separate from the annual expense ratio, so a low load says nothing about the cost of holding the fund.
• A back-end load leaves the eventual cost dependent on when you sell, which is typically unknown at purchase.
• Share classes multiply, and the same portfolio can be sold with several different charging arrangements, which makes like-for-like comparison harder than it should be.