What is back-end load?

Have you ever wondered about the rushed announcements towards the end of a mutual fund TV commercial? It contains multiple disclaimers for viewers and advises investors to understand all scheme related documents before investing in mutual funds. The fine print of mutual fund investments has various terms and conditions; it includes fee structure, market risk, redemption, switch, and other details.

A back-end load is one such term for mutual fund investments. Let’s discuss the meaning of back-end load, applicability, pros, and cons.

What is back-end load?

Most mutual fund investors are unaware of the back-end load of investing. It is also known as back-end sales charge or exit fee. The definition of back-end load is a deferred, contingent sales fee charged to investors at the time of redemption. Usually, the fee is a percentage of the current value of an investment and reduces with time. Some mutual funds reduce the back-end load to zero at the end of a pre-specified holding period.

Calculating back-end load

For example, you invest Rs. 100,000 in an equity mutual fund with an initial back-end load of 5%. The back-end load reduces to 3% if the investment period is more than 36 months and the back-end load is zero if the investment period is more than the stipulated period.

Suppose the investment value after 24 months is Rs. 180,000, and you decide to redeem Rs. 50,000. In this case, the mutual fund house will deduct a back-end load of Rs. 2,500 and remit the balance Rs. 47,500. At the end of 48 months, you decide to liquidate the entire holding. Regardless of the investment value, the back-end load is not applicable since the holding period is more than 36 months.

Criticism of the back-end load

Mutual fund experts believe that the back-end load is an unnecessary fee and levied regardless of the net return from investment. Some investors may withdraw funds to meet unanticipated expenditures, and the back-end load reduces the overall redemption value.

Mutual funds pay the back-end load to the intermediary and do not include it in the operating expense. Thus, it does not directly or indirectly impact returns from investment.

Fee Structures in Different Share Classes

Mutual funds offer various share classes with different fee structures for investors. A share class is distinguished using letters and provides other rights and duties to investors. The minimum investment amount, fee structure and back-end load vary based on the Shares class.

Class A – Class A shares charge a front-end load reduced from the initial investment.

Class B – Generally, Class B shares do not have a front-end load. Though, a back-end load is applicable on redemption.

Class C – Class C shares are low load funds. Typically, Class C shares do not want to levy front-end loads but charge low back-end loads. The operating expenses of Class C shares tend to be higher.

Benefits of Back-End Loads

Despite the criticism, there are various benefits of back-end load. These include:

• Redemption - Back-end load deters excessive trading or unnecessary early withdrawal. The back-end load may lure investors into redeeming funds in case of short-term gains. However, the back-end load cultivates the habit for long-term growth.

• Holding Period – Back-end load reduces with an increase in the holding period. Investors can even avoid it altogether with holding periods of five to ten years.

• Conversion – Class B shares often convert into Class A shares after six to eight years. The expense ratio of Class A shares is lower; therefore, the net return increases.

• Investment Amount – Mutual funds deduct the back-end load at the time of redemption. Till then, the mutual fund actively invests the entire amount. Mutual funds levy a front-end load at the time of investment, so the total amount available for investment is lower.

Bottom Line

While the back-end load seems excessive, investing in mutual funds may be quite lucrative. Hence, it would help if you did not consider the back-end load a deterrent for investing in mutual funds. Exchange-traded funds and no-load mutual funds are also widely available. Nevertheless, you must read the offer document carefully and fully know the terms and conditions before investing.