Schwab divests funds with sales charges
Imagine that a vendor offers you a streaming TV service that offers exactly the same movies and TV series that Netflix offers, at the same monthly cost. The only difference: You have to pay a $100 entry fee to join.
It’s hard to imagine anyone accepting the competitor’s deal. However, many investors acted similarly for years by buying 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 commission to a broker or other intermediary in order to invest. But these days, there are plenty of no-load alternatives to choose from. Furthermore, historical data does not show a substantial difference in performance between loaded and unloaded funds; in fact, Morningstar found that no-fee funds have a slightly better track record in recent years.
More and more investors 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 he will stop selling mutual fund share classes that carry sales charges.
As The Wall Street Journal reported, Schwab will no longer offer loaded share classes to clients, although clients who already own shares in such funds may continue to hold them with Schwab. “It’s a low-volume business that no longer makes sense for us to run,” a company spokeswoman told The Journal. (1)
The numbers support Schwab’s assessment. According to the Investment Company Institute, a mutual fund trade group, investors took in more than $500 billion from loaded share classes between 2010 and 2014; during the same period, they spent $1.34 billion on no-load classes. Many mutual fund firms offer some funds that would normally carry loads to retail investors with no load, making it even more illogical for investors to pay for something they can get for free. Schwab’s decision remains a sign of things to come in the mutual fund market.
This trend predates the Department of Labor’s new fiduciary rules, but requiring a broader swath of financial professionals to prioritize the financial well-being of clients will no doubt hasten the demise of cargo funds. Schwab has openly said that the new Labor rule was not the direct catalyst for his decision, but the changing standards may contribute to similar decisions by other companies in the future.
Some mutual fund companies may also drop certain stock classes, as more investors get smart enough to avoid them. One company, Waddell & Reed, said in February that it would merge Class A shares, which charge an upfront load, into institutional shares, which generally do not charge a load and offer lower expense ratios. Other mutual funds are likely to continue to offer load-bearing shares, if only to benefit from the few investors who don’t realize they could get a better deal elsewhere.
Fee-only financial advisors and other professionals who do not benefit from commissions on individual investment products have long steered their clients away from load funds. Mutual fund companies introduced back-end load and level-load funds in large part because some investors had begun to balk at the idea of paying a commission up front, but the fact is there’s no good reason to pay a broker 5 percent or more. to invest, no matter when you pay it.
If Schwab customers were still buying load fund shares in substantial amounts, you can be sure Schwab would be happy to continue offering them, at least in taxable accounts. Schwab’s decision to close its load-fund business is a sign that too many investors have caught on to the fact that load-funds are bad business.
Source:
1) The Wall Street Journal, “Charles Schwab will stop selling load mutual funds”