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Sunk Costs and Mutual Fund Sales Loads

A reader writes in, asking:

“I am currently at Edward Jones and of course was sold A-class mutual funds in 2009. I would like to move to Vanguard but had the high pressure sell today from the Edward Jones advisor that I already paid the commission for the funds and it would be dumb to move now. Is there any truth to it or does it not matter based on the other fees involved?”

The advisor is giving you a nonsense argument. At this point, the commission is what’s referred to in economics as a “sunk cost” because you have already paid the cost and there is no way to recover it. From a decision making perspective, sunk costs should be ignored.

For example, if you’re 45 minutes into a movie and you find yourself hating it, the fact that you paid $10 for your ticket is irrelevant when trying to choose between A) leaving or B) sitting through the rest of the movie. There is no financial difference between options A and B — neither option gets you your $10 back. (That is, your $10 is a sunk cost.) So the only thing that matters at this point is what you want to do with the next hour of your time: sit in the movie or be somewhere else?

The sales load on a mutual fund is like the ticket price for a crummy movie. Once you’ve paid it, it becomes irrelevant for future decision making purposes.

If it makes sense to continue holding A-shares of a given fund, it is only because you have some reason to think that the fund manager’s performance will more than offset the fund’s higher forward-looking cost (that is, the amount by which its expense ratio exceeds the expense ratio on a low-cost index fund in the same fund category).* The decision should not be affected either way by the commission that has already been paid.

*If we’re talking about a taxable brokerage account (as opposed to a tax-sheltered retirement account), there are additional factors to consider such as:

  • The tax-efficiency of the fund relative to an index fund (in most cases, actively managed funds have higher ongoing tax costs than index funds), and
  • Whether you would have to pay any taxes due to selling the actively managed fund.

…but the already-paid commission should still not be a factor.

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Comments

  1. Sunk costs are irrelevant! Love it.

  2. I like to think of sunk cost as the cost of buying a car, and once the warranty runs out it starts breaking down every month. If you need to pay some amount every month to get it fixed, does it matter how much it cost when you bought it or just how much a new one will cost compared to the maintenance?
    Ken

  3. Just one point on this…although I see this less often, sometimes people are sold a fund with a back-end sales load or redemption fee that *might* get waived after a period of time. If this is your situation, then you might want to stick it out with the funds until *after* the redemption period lapses (unless it’s something like five years and you still have four years to go). For example, suppose you bought a fund with a 2.5% front-end sales load and a 2.5% back-end sales load that is assessed only if you sell within 12 months. If you’re at month 10, then I’d wait 2 more months and then sell at the beginning of month 13 so you don’t lose an additional 2.5%.

  4. Mark Hook says:

    I closed my accounts with Edward D Jones last year at this time and transfered all assetts to Vanguard…. Ira,Roth Ira, Index funds outside of retirement and Individual stocks. It has been an excellent move for me. My objective was to simplify my investments and reduce costs by investing primarily in index funds. My overall returns for 1 year 9.6% with very minimal fees. (Unlike Edward D Jones) It couldn’t have been easier with Vanguard making the calls and transactions for me. I did not talk to my previous broker until after the transaction was over. He didn’t have much to say at that point other than he could have competed if I added a lot more to my portfolio with him.

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