Money Magazine
Money Magazine's undercover financial planner

Are American Funds a good buy?

The fund family has a great performance record, but there are other factors that determine future returns.

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By The Mole, Money Magazine's undercover financial planner

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Have future topics for the Mole to address? E-mail him at themole@moneymail.com.
SUBMIT

NEW YORK (Money) -- Question: My financial planner is continually suggesting American Funds. My concern is the 5.50% load. What is your opinion of American Funds?

The Mole's Answer: Considering I've never recommended a loaded fund in my life, my gut instinct is to advise you to always avoid the loads.

With that said, it's important to note that American Funds have consistently performed well. They've proved me wrong in my prediction that they wouldn't continue to significantly outperform their peer group by 1% to 2% per year.

Let's first take a look at American Funds and then examine the impact of the loads you are paying. I'll then give you my take on whether you should follow the advice of your planner.

The American Fund family is one of the largest three mutual fund families with assets of nearly $1.1 trillion dollars. Excluding front loaded fees, their average expense is a relatively low .96% for domestic stock funds, and 1.17% for international stock funds.

American has a reputation for discipline and minimizes stock turnover in their funds. This both lowers hidden costs and increases the tax efficiency of their funds.

With low costs and a disciplined approach, it's not surprising that Morningstar rates the American Funds Family well above the average.

American Funds are actively managed and are one of the few fund families to consistently beat their benchmark indexes. They are, however, sold through financial advisers only and they pay for that distribution by charging you "loads."

The average American Fund has bested its category in each of the past five years, and has done so by an average of 1.48% annually. In short, their performance has been phenomenal. Several American Funds are included in the Money 70 best mutual funds you can buy.

Look at the loads

You noted you were concerned about the 5.50% load you are paying to get in and you are right to be concerned. It sounds like your adviser is putting you in what are called A class shares. This means that for each $100 you invest, $5.50 immediately goes to fees, which leaves $94.50 to invest.

Now doing some simple math would tell you that if American Funds continue to beat their category average by 1.48% per year, it will take about four years to make up for that front-end load you are paying. Does that lead to the conclusion that I should recommend you continue to buy American? I would suggest that it's not so simple.

There is no guarantee that American Funds will continue to beat their peers by 1.48% per year. Now, admittedly, this may just be me digging in my heels and being stubborn considering I've said this before and been dead wrong.

While I could certainly be wrong again, I'd like to make the argument that it really doesn't matter much. Comparing anything to the mutual fund category average is setting the bar really low. You may already be aware that the average mutual fund significantly underperforms the stock market.

And those loads can really cut into the returns, even for a top performing fund family like American Funds. Vanguard, for example, beat its category average by 1.20% annually over the same five year period. While a bit less than the 1.48% advantage for American Funds, you would save the 5.5% upfront load. Thus, even if American continues to outperform Vanguard, it is likely you would still be better off avoiding the loads.

My Advice

I think it's a close call, but I'd recommend broad low cost index funds or ETFs from Vanguard, Fidelity, and iShares over the American Funds. I'd keep the American Funds you already bought since you've already paid the upfront fee but consider avoiding future loads altogether.

If you do continue buying American funds, explore lower cost classes like C shares that will have no front-end loads but will cost you a bit more each year. Stay away from B shares that will cost you the most in the long run.

I've been a fan of American Funds for quite some time. Your adviser is selling you some good funds, but I still think you can do a bit better by avoiding the loads altogether. To top of page

Class A and 529-A share sales charges (on gross amount invested)
Amount of sale/account value Growth, growth-and-income,
equity-income and balanced funds
Bond and tax-exempt bond funds
Less than $25,000 5.75% 3.75%*
$25,000 but less than $50,000 5.00 3.75*
$50,000 but less than $100,000 4.50 3.75*
$100,000 but less than $250,000 3.50 3.50*
$250,000 but less than $500,000 2.50 2.50
$500,000 but less than $750,000 2.00 2.00
$750,000 but less than $1 million 1.50 1.50
$1 million and above 0.00† 0.00†
Source: Americanfunds.com
*The sales charge for purchases of less than $500,000 for Intermediate Bond Fund of America®, Limited Term Tax-Exempt Bond Fund of AmericaSM and Short-Term Bond Fund of AmericaSM is 2.50%. The sales charge declines for larger accounts. Please see the funds’ prospectuses for more information.
† There is no initial sales charge on purchases of $1 million or more. A 1% contingent deferred sales charge (CDSC) may be assessed if a redemption occurs within one year of purchase. Tax-exempt bond funds, The Tax-Exempt Money Fund of AmericaSM and The U.S. Treasury Money Fund of AmericaSM are not available through the CollegeAmerica 529 plan. See fund prospectuses for details.
Worried about your investments? Get a makeover from Money Magazine. E-mail us at makeover@moneymail.com.

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When to tell your planner you'll sleep on it: Why you shouldn't rush to act on advice, no matter how good it sounds.
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