Back end sales load: Meaning, Criticisms & Real-World Uses

What Is Back End Sales Load?

A back end sales load, also known as a contingent deferred sales charge (CDSC), is an investment fee that investors pay when they sell shares of certain mutual fund share classes, typically Class B shares, before a specified period. This charge is not deducted upfront at the time of purchase but rather at the time of redemption, declining over a period, often between five to eight years, until it reaches zero. The primary purpose of a back end sales load is to compensate the financial advisor or broker who sold the fund shares, especially when a commission was not paid at the initial purchase. Investors will typically see this fee detailed in the fund's prospectus.

History and Origin

For many years, mutual funds primarily compensated brokers through upfront commissions known as front-end loads. However, in the mid-1980s, the fund industry introduced a new structure to attract investors who preferred not to pay a sales charge at the time of purchase: the deferred sales charge, or back end sales load. This innovation allowed investors to buy fund shares without an immediate deduction, with the understanding that a fee would be levied if they redeemed their investment within a set number of years. This deferred payment model was designed to incentivize longer-term holding periods while still providing compensation to the selling agents. This shift also coincided with the broader evolution of mutual fund distribution, including the adoption of Rule 12b-1 by the Securities and Exchange Commission (SEC) in 1980, which allowed funds to pay for marketing and distribution expenses directly from fund assets over time.⁴

Key Takeaways

A back end sales load, or contingent deferred sales charge (CDSC), is a fee paid upon the redemption of mutual fund shares.
The charge typically decreases over a specified holding period, often five to eight years, eventually reaching zero.
It is commonly associated with Class B shares of mutual funds and is designed to compensate the selling broker.
Investors seeking to avoid this load must hold their shares for the full declining schedule.
The fee is usually calculated as a percentage of the lesser of the original investment or the current net asset value at the time of redemption.

Formula and Calculation

The calculation of a back end sales load is typically a percentage of either the initial investment amount or the current net asset value (NAV) at the time of redemption, whichever is less. This calculation method is designed to prevent investors from paying a sales load on any appreciation their investment portfolio might have experienced. The specific percentage charged depends on how long the shares have been held, decreasing annually until it reaches zero.

The formula can be expressed as:

\text{Back End Sales Load} = \text{Min}(\text{Initial Investment}, \text{Current NAV at Redemption}) \times \text{Applicable Load Percentage}

Where:

Initial Investment: The original amount of money invested.
Current NAV at Redemption: The total value of the investment at the time of selling, based on the fund's net asset value per share.
Applicable Load Percentage: The specific percentage determined by the fund's schedule based on the holding period. This percentage declines over time.

For example, a fund might have a back end sales load schedule of 5% in year 1, 4% in year 2, 3% in year 3, and so on, until it becomes 0% after year 5.

Interpreting the Back End Sales Load

A back end sales load is designed to discourage short-term trading of fund shares and ensure that the selling financial advisor is compensated for their services over a longer period. For an investor, understanding this fee is crucial for proper financial planning. If an investor anticipates needing access to their funds within the period during which the load applies, they might incur a significant cost that erodes their returns.

The declining nature of the back end sales load means that the longer an investor holds the shares, the less they will pay if they eventually redeem them. This encourages a buy-and-hold strategy, aligning with the long-term investment philosophy often promoted for diversification and wealth building. Investors should always review the fund's prospectus to understand the specific CDSC schedule before investing, paying close attention to the number of years required for the load to reach zero. This transparency helps investors evaluate the total cost of ownership.

Hypothetical Example

Consider an investor, Sarah, who buys $10,000 worth of mutual fund shares that carry a back end sales load. The fund's load schedule is:

Year 1: 5%
Year 2: 4%
Year 3: 3%
Year 4: 2%
Year 5: 1%
Year 6 and beyond: 0%

Suppose Sarah's investment grows to $12,000 after 2 years. Due to an unexpected expense, she decides to redeem her shares at the beginning of year 3.

To calculate the back end sales load:

Determine the applicable load percentage: At the beginning of year 3, the load is 3%.
Identify the lesser of initial investment or current NAV: $10,000 (initial investment) is less than $12,000 (current NAV).
Calculate the load: $10,000 (initial investment) (\times) 3% = $300.

Sarah would pay a $300 back end sales load. She would receive $11,700 ($12,000 - $300) from her redemption. If she had held the shares for 6 years or more, she would not have paid any back end sales load. This example illustrates how the back end sales load can impact an investor's net proceeds, especially with shorter holding periods.

Practical Applications

Back end sales loads are predominantly found in specific classes of load fund mutual funds and variable annuities. These fees are structured to provide intermediaries, such as brokers and financial advisors, with compensation for selling the product without an immediate deduction from the investor's initial capital. For investors, the presence of a back end sales load impacts their liquidity planning and investment horizon. Funds with CDSCs are generally suitable for long-term investors who intend to hold their shares beyond the period during which the load applies.

From a regulatory perspective, bodies like the Financial Industry Regulatory Authority (FINRA) impose limits on the maximum sales charges that mutual funds can levy, including back end loads, to protect investors.³ These regulations ensure that fees do not become excessive and that investors are provided with clear disclosures regarding all charges. The SEC also provides guidance on these fees, emphasizing that investors should review the fee and expense table in the prospectus carefully.²

Limitations and Criticisms

While designed to align interests for long-term investing, back end sales loads face several criticisms. One major drawback is their impact on investor returns if shares are redeemed prematurely. An investor might see their capital gains significantly reduced by the load, especially if the market has not performed strongly, or if unforeseen circumstances necessitate an early withdrawal. This can create an "exit penalty" for investors, limiting their flexibility.

Another criticism revolves around the potential for conflicts of interest for financial advisors. Advisors may be incentivized to recommend mutual fund shares with back end loads (such as Class B shares) because they receive an upfront commission from the fund company, even if a no-load fund or a fund with a front-end load might be more suitable for a client's specific financial situation or shorter time horizon. Although regulations require disclosure, the complexity of various share classes and fee structures can make it challenging for the average investor to fully understand the total cost over time.

Furthermore, the popularity of back end sales loads has declined in recent years, with some fund companies discontinuing these options amidst regulatory scrutiny and evolving industry standards.¹ This trend reflects a broader move towards fee transparency and potentially lower-cost investment vehicles.

Back End Sales Load vs. Front End Sales Load

The primary distinction between a back end sales load and a front end sales load lies in when the fee is assessed.

Feature	Back End Sales Load (CDSC)	Front End Sales Load
Timing of Fee	Paid when shares are redeemed (sold).	Paid when shares are purchased.
Amount Deducted	Deducted from the redemption proceeds.	Deducted from the initial investment amount.
Investor's Money	The full initial investment goes into the fund.	Less than the full initial investment goes into the fund, as the load is taken first.
Load Schedule	Typically declines over time, often to zero.	Usually a fixed percentage, but may have breakpoint discounts for larger investments.
Common Share Class	Commonly associated with Class B shares and sometimes Class C shares.	Most common with Class A shares.

While a back end sales load allows the investor's entire initial capital to be invested, potentially benefiting from full market exposure, a front end sales load reduces the amount of capital initially invested. For instance, with a 5% front end load on a $10,000 investment, only $9,500 would be invested in the fund. Conversely, a $10,000 investment with a back end load would have the full $10,000 invested, but a fee would be assessed if redeemed within the specified period.

FAQs

What is the typical duration for a back end sales load to decline to zero?

A back end sales load typically declines to zero over a period ranging from five to eight years. Each year the shares are held, the percentage of the load usually decreases until it is completely eliminated. After this period, shares can often convert to a different class, such as Class A shares, which may have lower operating expenses in the form of a lower expense ratio.

Can I avoid paying a back end sales load?

Yes, you can often avoid paying a back end sales load by holding your mutual fund shares for the entire period specified in the fund's prospectus during which the load applies. Once this period expires, the back end sales load becomes zero, and you can redeem your shares without incurring this specific fee. Additionally, some funds offer waivers for certain circumstances, such as death, disability, or systematic withdrawals, which should be detailed in the prospectus.

How does a back end sales load affect my investment returns?

A back end sales load directly reduces your net proceeds when you redeem your shares within the specified load period. This means that even if your investment portfolio has generated positive returns, the load will diminish the amount you receive. For example, a 3% back end sales load on a $10,000 redemption would reduce your payout by $300, irrespective of the fund's performance during that time. This makes understanding all fees, including any redemption fee that may also apply, critical to evaluating your overall return.