Paying either a back-end or a front-end load on a mutual fund reduces your total return. However, the effect of front-end loads is generally much more pernicious because it instantly reduces the amount actually invested. Someone who invests $10,000 with a front end load of 5% will actually only be investing $9,500 because $500 will be automatically subtracted for the load.
If someone invests $10,000 for a year with a front-end load of 5% and gets a 10% percent return, they will end up with $10,450. Had there been no front-end load, they would have had $11000. The amount invested will start out smaller, and their nest egg will always remain smaller than it would have been without the load. Over time, these kinds of figures will make a substantial difference.
However, back-end loads hurt returns too. If an investor pays a back-end load of 5 percent on that $11,000 when they choose to withdraw the money, they will end up with $10,450. These calculations make it appear that front-end and back-end loads have the same effect. However, they do not. The difference has to do with the different purposes of the two kinds of loads, and with the way most investors behave, or should behave.
Front-end loads are essentially designed to compensate the sales force and increase the size and income of a mutual fund. Back-end loads, on the other hand, are often intended to reduce the flow of “hot money” that jumps around from fund to fund, constantly seeking the latest, hottest, investment category, with the currently highest return.
Hot money makes the job of a mutual fund manager more difficult and expensive, because managers cannot as freely invest for the long term. Managers plagued by investors who jump in and out must keep larger amounts of cash on hand, and this tends to reduce returns for all their investors. Not every mutual fund has problems with hot money, but some do, and they may decide to charge a back-end load to discourage people from moving quickly in and out of their fund.
Front-end loads ding the results of every investor who puts money in a given class of mutual fund. Back-end loads, in most cases, do not reduce the returns of investors who leave their money to grow in a fund for longer than a given period, which might be as brief as six months, or up to ten years while gradually decreasing.
Therefore, if someone invests in the average fund, and leaves their money alone, he or she will probably not be affected by a back-end load. Some funds have no back-end load, and some have an onerous one. The easiest way to find out is to ask customer service, and the most reliable way to reassure yourself is to read that dull prospectus.
Some funds are very successful, with returns so wonderful that investors do not mind paying a load. When investing times are tough, though, and investors settle in for the long term, they are wise to avoid any load they can.
Bogle on Mutual Funds by John Bogle
The Bogleheads’ Guide to Investing by Taylor Larimore and others