Front End Load Definition
Front End Load refers to the commissions or the one-time charges deducted from the investments at the time of their initial purchase. It generally applies to mutual funds, insurance plans, and annuity plans. The load is removed upfront and the net amount afterload, which finally goes into the investment stream.
How Does it Work?
Front end loading is the charge paid as compensation to the financial mediators for finding and selling the desired investment as per the investor’s specifications. These are only one-time charges that only need to be paid originally at the time of purchase and not repeatedly. It reduces the amount of money invested as these charges are deducted from the primary deposit amount.
Front end loading is imposed as a percentage of the cumulative investment or premium paid either as a mutual fund, life insurance, or annuity. This percentage differs among investment companies but generally fluctuates within the spectrum of 3.75% to 5.75%. Lower front-end charges are levied in mutual funds, annuities, life insurance investments, etc., and comparatively higher charges are charged for equity-based mutual funds.
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Examples of Front End Load
Let us assume that Mr.X has invested $1,00,000 in DSP Merrylynch’s mutual fund in the top 100 equity scheme. The Front End load applicable for the scheme is 5%. In this, the front end load for the transaction that will go to the investment company will be $1,00,000 * 5% = $ 5,000. Hence the actual investment in the equity scheme will be $1,00,000 – $5,0000 = $95,000. The Portfolio of Mr. X will reflect investments in mutual funds to the tune of $95,000. The risk-free rate of return is assumed to be 10%. So the fund house will have to generate a 15.79% yearly rate of return to reach $1,10,000 i.e., at par had the $1,00,000 been invested in risk-free assets.
Let us assume the Mr.A has invested $10,000 in a fund that has a front end load of 5% and the Intermediary commission of 10% of the 5% load charged. In this case, $10,000 * 5% = $500 will be the front end load, which shall be deducted from the Investments. Hence Mr. A’s investments will be recorded as $10,000 -$500 = $9,500 in the Assets in Accounting. For the fund house, $500 will be income generated of that 10% will be remitted to the intermediary for executing the trade. The commission paid to the intermediary will be $500*10% = $50. Thus the intermediary can generate $50 as income for recommending the right plan to the investor and increasing the inflow of the mutual fund.
- Investors are willing to pay the front end load to the financial intermediaries since they conduct the required research on behalf of the investor on which fund to buy and what are the prospects of the same.
- Those who lack knowledge about the workings of the Mutual Funds find this route attractive since they get necessary information and inputs from the intermediaries by paying a small number of fees.
- Retail investors do not have to do the entire process themselves. The intermediary does the same on behalf of their clients.
- High loaded funds can have an impact on the aum and the comfort of the investors.
- Those investors who are experts in the financial markets and know the working of the fund houses will not go to the intermediaries for the investment decision. Instead, they would prefer to do their research and select the right fund.
- With the direct plans launched by the fund houses, it is now very easy for even a layman to invest in the funds directly without going to the brokers and paying a high amount of fee.
- Not appropriate for the conservative investor.
- Less popular nowadays since the back end load system has taken over the market, and people prefer to pay a back end load on their redemptions from the profit generated rather than lower their cost & investments upfront.
This has been a guide to what is Front End Load and its definition. Here we discuss the examples of Front End Load along with advantages and disadvantages. You can learn more about finance from the following articles –