index funds are supposed to be cheap to own because they don't incur high trading costs and their strategy isn't exactly rocket science. They simply invest in the underlying stocks of the
Yet 17 fund companies add sales charges to their index funds, in one case as much as 5.75%, according to
Why pay a load on this kind of fund? The people who charge loads say they're for the benefit you gain from knowing the broker who sells the funds to you.
"Basically the commissions on all the products we sell are
for the overall service that the broker is providing," says Jim Fusco, a spokesman for
Morgan Stanley Dean Witter
. "It's part of the whole value of the relationship with the broker."
Morgan Stanley Dean Witter sells A shares of its
MSDW S&P 500 Index fund with a 5.25% front-end load.
Victory Stock Index fund charges a higher sales load -- 5.75% -- for an S&P index fund, according to Lipper. A Victory spokesman did not respond to a call for this story.
Fusco points out that the B and C shares of the MSDW fund don't have front-end loads, but they do have 1.5% expense ratios, which are high when compared with an average of 0.54% for all S&P 500 index funds tracked by Lipper. By paying the sales commission on the A shares, investors can get a lower expense ratio of 0.75%, but it's still higher than average.
An index fund with a broker's fee "is really a contradiction in terms, because the benefit of the index fund is really that it's low cost," says Sheldon Jacobs, editor of the
No Load Fund Investor
and a proponent of indexing.
Brian Mattes, a spokesman at the
, says it's hard to make a case for loads when it comes to index funds.
"There really is not enough difference among index funds to justify that kind of a load," Mattes says. "You have no chance of outperforming the market, and you'll forever be behind the market because of the compounding effect of what you paid."
If you invest $10,000 in a fund that carries a 5.25% load, you're really only investing $9,475 after the commission. Your index fund would then have to gain 5.54% just to earn your original money back. So while these loaded funds might have absolute returns in line with those of their S&P tracking peers, on a load-adjusted basis, they don't.
In fact, these 17 funds fell to the bottom of the Lipper universe for 1998 when their returns were calculated on a load-adjusted basis. The Victory Stock Index fund, the one with the highest load, was at the bottom of the list with a return of just 20.4%. That's quite a bit lower than the S&P 500 itself, which posted a 28.6% return in 1998.