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Investors should avoid advisors who insist on back-load mutual funds

by Wayne Cheveldayoff, 2004-02-26

The terms “back-load”, “front-load” and “no-load” relate to the amount of commission, if any, investment advisors earn for selling mutual funds to investors.

The back-load version of a mutual fund is the least desireable for investors for a number of reasons. It can and should be avoided.

If you already own back-load funds, there are ways to extricate yourself.

If your advisor says back-load is the only way he or she will work with you, look for another advisor.

Many investors may not even know if their mutual funds are back-load. Some advisors don’t explain the different load types or offer a choice. They sometimes say things like “there’s no commission on this investment” but don’t go any further.

Investors often find out that they’re in back-load funds as a rude awakening when they want to switch to a fund at another fund company and are then informed they will get hit with a major redemption charge if they do so.

Here’s how the load system works for equity mutual funds.

Most fund companies, like Fidelity, Mackenzie and CI Funds, offer the same fund in two commission formats – back-load and front-load. The management expense ratio (MER) is the same in each case.

With the back-load version, the fund company pays the advisor a commission of about 5 per cent of the amount invested. Thus, the investor pays no up-front commission. The fund company also pays the advisor a trailer fee of 0.5 per cent a year.

However, the problem is that if the investor wants to sell the fund anytime within the first six years, a sizeable “deferred sales charge” will apply. A typical deferred-sales-charge schedule is 6 per cent in the first year, 5.5 per cent in the second, 5 per cent in the third, 4.5 per cent in the fourth, 3 per cent in the fifth, 1.5 per cent in the sixth and zero after six years.

The front-load version has no deferred sales charge. Investors can sell a front-load fund at any time without a redemption fee (although fund companies usually charge a 2-per-cent fee in the first couple months to discourage active traders). Advisors may charge an up-front sales commission of between zero and 5 per cent and they receive a 1-per-cent trailer fee as long as the investor holds the fund.

The no-load variety, usually offered by chartered banks directly to customers, has no up-front commission or deferred sales charge and sometimes no trailer fee. For this reason, no-load funds usually have lower MERs.

There is a fourth format that can only be accessed by advisors who charge fees directly to clients rather than receive commissions or trailer fees from the fund companies. The MER on this fund version is 1 per cent lower than back and front-load versions, giving the advisor room to charge the 1 per cent directly to clients.

One problem with back-load funds is that investors, once in them, feel trapped. Most investors find it a psychological stumbling block to pay the deferred sales charges when logic dictates that they should sell.

I’ve seen many situations where the deferred sales charges have stopped investors from doing the right thing, such as diversifying their fund portfolio, leaving poorly performing funds and selling when the key individual managing the fund leaves to join another fund company. In one situation, an investor who borrowed heavily to buy mutual funds got hung up on the deferred sales charge and didn’t sell when the market started moving lower in 2000; she didn’t sell because of the 6 per cent deferred sales charge and her fund portfolio subsequently lost more than 30 per cent.

Another problem with back-load funds is that the advisor’s interests sometimes take precedence over those of investors. Some advisors find excuses to move their clients into new funds after six years just to get another 5 per cent back-load commission.

Advisors’ interests are much better aligned with investors’ interests in front-load funds. It’s worth paying an up-front commission of 1 or 2 per cent, if needed, to achieve this and have the mental flexibility to change to different funds or simply sell when it makes sense.

But most people will find they don’t have to pay up-front commissions for front-load funds. While they won’t offer it initially, advisors often will accommodate their clients in this way in order to keep them.

If they won’t, look around. There are a growing number of advisors across the country who have decided to forego sales commissions of any kind and work for only the 1 per cent trailer fee they get from having their clients in front-load funds.

It’s worth seeking out such advisors because they have recognized the problems with back-load funds and are prepared to build their practice in a way that fully aligns their interests with those of their clients. With front-load funds, the advisor has a strong interest in making sure the value of the client’s portfolio goes up in order to have the 1-per-cent trailer fee apply to a higher number.

For those already in back-load funds, there is a way to gradually pull money out without paying the deferred sales charge. Most fund companies forego the deferred sales charge on withdrawals of up to 10 per cent each year (based on either the original cost or current value).

Investors can use this exemption to gradually move into the front-load version of the same fund. Note that the 10 per cent exemption is not cumulative; you can’t carry forward unused room from year to year.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2004 Wayne Cheveldayoff