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Schwab Ditches Funds With Sales Charges

reception desk with Charles Schwab sign on the wall behind it
photo by Mike Mozart

Imagine a salesman offers you a streaming TV service that offers the exact same movies and TV series that Netflix does, at the same monthly cost. The only difference: You have to pay a $100 entry fee in order to join.

It is hard to imagine anyone taking the competitor’s deal. Yet many investors acted in a similar way for years by purchasing load mutual funds instead of no-load alternatives.

When the first modern mutual funds arrived in the 1920s, load funds were the only type of funds available. Investors paid a fee to a broker or other intermediary in order to be able to invest. But these days, there are plenty of no-load alternatives to choose from. What’s more, historical data shows no substantial performance difference between load and no-load funds; in fact, Morningstar found that no-load funds have a slightly better track record in recent years.

Increasing numbers of investors now realize that paying more for an investment does not mean that the investment is better. The most recent evidence comes in the form of Charles Schwab’s announcement that it will stop selling mutual fund share classes that carry sales loads.

As The Wall Street Journal reported, Schwab will no longer offer share classes with loads to clients after today, though customers who already own shares in such funds may continue to hold them at Schwab. “It’s a low-volume business that no longer makes sense for us to administer,” a company spokeswoman told The Journal.

The numbers support Schwab’s assessment. According to the Investment Company Institute, a mutual fund trade group, investors pulled more than $500 billion from share classes with loads between 2010 and 2014; over the same period, they invested $1.34 trillion in no-load classes. Many mutual fund firms offer some funds that would normally carry loads to retail investors on a load-waived basis, making it even more illogical for investors to pay for something they can get for free.

At Palisades Hudson Asset Management L.P., we have never dealt with load funds, so Schwab’s decision will not affect us directly. Still, Schwab’s decision is still a sign of things to come in the mutual fund market.

This trend predated the Department of Labor’s new fiduciary rules, which I and my colleague Shomari Hearn wrote about recently in this space. But requiring a broader swath of financial professionals to place clients’ financial well-being first will certainly hasten the demise of load funds. Schwab has said outright that the new Labor rule was not the direct catalyst for its decision, but the changing standards may contribute to other firms’ similar decisions down the line.

Some mutual fund companies may abandon certain share classes as well, as more investors become savvy enough to avoid them. One company, Waddell & Reed, said in February that it would merge A-class shares – which charge a load up front – into institutional shares, which typically charge no load and offer lower expense ratios. Other mutual funds will probably continue to offer shares that include loads, if only to profit from the few investors who do not realize they could get a better deal elsewhere.

Fee-only financial advisers and other professionals who do not benefit from commissions on individual investment products have long steered their customers away from load funds. Mutual fund companies introduced back-end load and level-load funds largely because some investors had begun to resist the idea of paying a commission up front, but the fact remains that there is no good reason to pay a broker 5 percent or more in order to invest, no matter when you pay it.

If Schwab customers were still buying shares of load funds in substantial numbers, you can be sure that Schwab would be happy to keep offering them, at least in taxable accounts. Schwab’s decision to shutter its load fund business is a sign that too many investors have wised up to the fact that load funds are a bad deal.

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