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Mutual funds are one of the most famous avenues for investors due to their consistent returns compared to stocks. Each mutual fund scheme includes multiple companies’ equities from the same or different sectors in varying proportions. If a few stocks in the portfolio do not perform well, the upward rise of the others reduces the risk.
However, not all funds are created equally. You must choose a fund that matches your risk tolerance while offering returns to help you reach your goal. In order to select the best scheme, you will require expert guidance, which advisors can offer.
But do the advisors provide their services for free? The answer is no; they collect a commission on every investment. So, who pays for this commission? To understand this, dive into the concept of front-end load.
Understanding front-end load
A front-end load is a fee you pay when you acquire units of a mutual fund, annuity, or other investment product. It is a percentage of the amount you invest and is deducted from your investment before it is invested in the fund.
The load compensates the advisor in the form of a commission for recommending when to buy or sell specific schemes. It is worth mentioning that when buying a mutual fund, you must consider operating expenses, management fees, and a few other charges as well.
The primary objective of the front end load in mutual funds is to discourage investors from impulsively buying and selling their units and incurring losses.
How does front end load work?
Let’s get this with a front end load mutual fund example.
Suppose you invest Rs 10,000 in two mutual funds, A and B. Both offer the same annual return of 10%. Fund A has a 5% front-end load, while B has no load.
After one year, your fund A investment will be worth Rs 9,975 (Rs 9,500 x 1.1 — Rs 500). On the other hand, your investment in fund B will grow to Rs 11,000 (Rs 10,000 x 1.1).
This example clearly states that the loan reduces your return by Rs 1,025.
Advantages of front end load in mutual funds
Schemes with front-end loads offer various advantages that you should be aware of.
- Professional advice: Since load compensates the advisor’s compensation, you, as an investor, receive tailored investment suggestions based on your risk appetite, future objectives, and retirement aspirations.
- Long-term commitment: Mutual funds, like stocks, are vulnerable to price fluctuations. This investment channel’s net asset value (NAV) fluctuates in the short term, potentially causing investors to withdraw their funds even if they are losing money. However, with load, you will think twice about redeeming, which will help you weather short-term volatility.
- Lower expense ratios: This ratio represents the percentage of the scheme’s fund spent on management, administration, advertising, and other associated expenses. Mutual funds with front-end loads cover the preceding charges to some extent, so the expense ratio is typically lower.
Drawbacks of front end load in mutual funds
The downsides of front-end loads are:
- Upfront Cost: Since it is an upfront fee, it reduces the original investment amount. In the event of an emergency in which you wish to redeem the investment, the NAV is unlikely to have soared to a range enough to cover the amount of the load you paid, resulting in a loss for you.
- Limited Flexibility: Mutual funds with front-end loads rarely allow you to redeem units or switch to a new scheme until a specific period. If you do this, you may have to incur additional fees.
Distinctions between front end load and back end load in mutual funds
Many investors assume the front and back-end loads are the same, but they are not. Here is a tabular description of the same.
| Description | Front end load | Back end load |
| Meaning | You pay this fee upfront at the time of the initial purchase of the product. | You pay this fee when you sell or withdraw from the product, usually within a specified period. |
| Applicability | It is more common for equity-based mutual funds, as they have higher sales and marketing costs. | It is more common for bond mutual funds, annuities, and life insurance policies. |
| Occurrence | It is a one-time fee that does not recur. It also means that the product has lower ongoing fees and expense ratios. | A back-load is a deferred fee that may recur if you sell or withdraw from the product multiple times. |
Conclusion
Front-end load is a sales commission subtracted from the initial capital investment. This fee is a commission for independent financial advisors who provide expert advice to ensure your investment yields return with calculated risk and you easily achieve your goals. It is crucial to note that several fund houses can waive the load fee if you invest a hefty sum, usually in crores. To learn more, subscribe to StockGro.
Frequently Asked Questions
A front-end load is a sales charge an investor pays upfront when buying shares of a mutual fund, annuity, or other investment product. It is usually a percentage of the total investment amount and reduces the actual amount invested in the product.
The percentage of the front-end load varies among different investment companies and products, but it usually ranges from 3.75% to 5.75%.
You can reduce the front-end load by taking advantage of breakpoints, which are discounts on the sales charge for larger investments or frequent purchases.
You can do this by looking at the scheme’s NAV. It reflects the actual amount invested in the product and can be used to calculate the return on investment.
Front-end loads compensate financial intermediaries, such as brokers, advisors, or planners, for finding and selling products that match the investor’s needs, goals, and risk tolerance.