Mutual Fund Commission Structure

Most mutual fund companies operate on a for-profit basis. They generate profits via sales commissions, expense ratios, and fees. The mutual fund industry has by no means standardized how they extract money from the funds. We will try to simplify this rather complex and very important subject. In addition, we have created a series of questions pertaining to commissions one should ask prior to purchasing shares of a mutual fund. This is very important because money taken from your account via commissions will greatly influence your Return On Investment (ROI).

In general, there are two types of mutual funds, loaded and no-load funds.  Funds that charge a sales commission are referred to as "loaded funds." Mutual funds that do not charge a sales commission are called "no-load funds." 

For the most part, there are no good reasons to invest in a loaded fund.

No-load funds put all your money to work earning money whereas loaded funds remove a percentage of your investment as an entrance fee. The mutual fund industry has tried to standardize the sales commission structure of the loaded funds by forming fund share classes, refer to the table below.

This table should be used as a guideline since there is a great deal of latitude in the class definitions. Classes differ in their pricing conventions and/or annual fees. Because there is wide variation even within a single class of mutual funds, reading the fund's prospectus is the only way to be certain of its pricing and fee structure, regardless of its class. The industry has succeeded in complicating the commission structure to the point where the average investor does not fully understand how they negatively influence the investor's return on investment. Proceed with caution.  

In summary, the investor class shares (shares of no-load funds) will offer the highest returns, all things being equal. Loaded funds must materially outperform their no-load companions to offset high expenses which reduce net performance (real performance).  To determine the exact sale commission structure, consult the funds prospectus or one of the fund's advisors. 

All funds (no-load and loaded) are accompanied with an expense ratio

Both load and no-load funds apply a charge, stated as an annual percentage, that shareholders pay for a mutual fund's operating expenses (12b-1 fee), management fees and other overhead expenses. This percentage can range from 0.2-3.5% with the average being 1.42% in 1996. The money is withheld from the fund's current value and is not an out-of-pocket cost to the investor. For example, assume a fund actually appreciated 12% over the last 12 months and the fund has an expense ratio of 1.5%. The net or adjusted return, 10.5%, is calculated by subtracting the expense ratio percentage from the actual return (12 - 1.5 = 10.5%). 

Shareholders pay the expense ratio indirectly by receiving a lower return than the mutual fund, refer to the table below.

Notice how the mutual fund company makes money whether the market value of the fund appreciated or depreciated. Remember, money is never taken out of your pocket. The commission is deducted from the actual return. For example, assume an investor places $10,000 in a mutual fund and 12 months later the fund appreciated 17%, refer to the table below. Note: this calculation is simplified for demonstration purposes. The actual formula used to calculate expense ratio is includes several factors that change from day-to-day.  

Because there is an expense ratio of 2% the investor's portfolio appreciates 15%. The mutual fund earns $200. The exact principle holds true when the fund depreciates.  Because there is an expense ratio of 2%, the investors portfolio depreciates 2% more than the mutual fund's value. As a result the fund earns $200 whether the fund appreciates or depreciates. Again, the calculations used here have been oversimplified to demonstrate a point. 

Mutual fund companies make money regardless of the fund's performance, size or experience.