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How does a no load mutual fund work?

POSTED: July 17, 2008 5:00 a.m.

Recently we looked at some of the differences between an online discount brokerage firm, a stock broker that charges a commission for each transaction, and a financial advisor that charges a flat percentage of the amount of money invested. This week we’ll look at how one common type of investment, a no load mutual fund, works.

As discussed last time, no load mutual funds are typically purchased through an online discount brokerage firm or directly through the company that manages the funds. Some common no load mutual fund companies are Vanguard and Fidelity. No load mutual funds are given their name because there is no “load” or commission charged when purchasing one. Because there is no commission, all of the dollars that you invest will go to work immediately.

Though you will not pay a commission to purchase a no load mutual fund it is important to note that all mutual funds have ongoing annual expenses. These expenses are often listed in the fund’s prospectus as the “expense ratio.” Each fund has a prospectus that offers detailed information on expenses, returns, management style, management tenure, available share classes, and other relevant information. You should always get a copy of a mutual fund’s prospectus before purchasing the fund.

As listed in the fund’s prospectus, the expense ratio is the percentage of the fund that will be taken out to cover the expenses of running the fund on an annual basis. Again, all mutual funds have this expense, whether they have a load or are no load. The mutual fund company uses this money to pay the managers of the fund as well as cover bookkeeping, legal and other miscellaneous fees. This is also the main way that the mutual fund company makes money. This annual expense can vary widely – I’ve seen expense ratios as low as 0.10 percent to well over 2 percent.

In summary, all funds have an annual expense ratio though the amount of this expense varies from one fund to another. Typically you will only be charged a commission when purchasing funds through a stock broker. All of the expenses for each fund, as well as other helpful information, can be found in a fund’s prospectus.

I would be amiss if I did not give a word of caution here. I have seen accounts of people who have invested on their own, without the aid of a professional money manager or stock broker, in order to pay lower expenses and avoid commissions. Some of them have lost nearly all of their money because they did not know what they were getting into. Always remember that it is the amount that you have left that counts, not how much you saved. It does no good to save money on commissions, only to lose all of the money on a poor investment. On the other hand, I have met people that have done incredibly well investing on their own. The difference is discipline and education. Make sure that you spend time developing both if you choose to invest in no load mutual funds or otherwise invest on your own.

Proverbs 15:22 says, “Plans fail for lack of counsel, but with many advisors they succeed.” If you are not sure about what to do, talk to someone that has gone down the road before you. Find someone that has succeeded at investing in no load mutual funds as well as someone that has done poorly. Also, talk to someone that deals with an experienced investment professional and find out what their experience has been like. There are many tools available, just don’t forget to use them.

Jeff Hupman is a financial advisor with Christian Values Investing. Reach him at 748-9321.

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