As with any for-profit business enterprise, the mutual fund industry charges fees for the services it offers. In their most basic form, these services consist of managing a pool of commingled assets in accordance with an investment strategy. That strategy may include outperforming an index over time. In fact, this strategy is the lifeblood of the actively managed fund component of the industry.
A well-managed fund will tend to grow in popularity and earn more investors over time. However, for several decades now, and for reasons that used to make much more sense than they do today, mutual funds have charged existing investors for marketing and promoting their services to prospective investors. These charges are known as 12b-1 fees.
Key Takeaways
- A 12b-1 fee is an annual marketing or distribution fee on a mutual fund charged to investors.
- The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund's expense ratio.
- It is generally between 0.25% and 0.75% (the maximum allowed) of a fund's net assets and must be disclosed on the fund's prospectus.
The Basics of the 12b-1 Fee
A mutual fund charges its investors a 12b-1 fee to pay for marketing and promotion expenses. According to a discussion of 12b-1 fees on the website for the Securities and Exchange Commission (SEC), "these fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the fund's investors."
It also details that 12b-1 fees first emerged in the 1970s during a period when mutual funds were seeing significant redemptions and wanted an avenue to help attract new assets. The funds needed sufficient assets to protect existing investors from the fund managers' having to make forced sales at depressed asset prices or when stocks and bonds were not trading at favorable levels. The fee's official name stems from a 1980 SEC rule implemented to authorize its use.
Fast forwarding approximately half a century, the ability for funds to charge 12b-1 fees has grown more controversial. Mutual funds are much more popular these days, which makes the original motivation for creating the fee much less meaningful. Funds are also much larger, with the largest managing hundreds of billions of dollars in assets. 12b-1s also have a percentage fee, such as 25 basis points or 0.25% of all the assets managed in a fund. With billions under management, it is difficult to see the need to charge investors to market the fund to other potential investors. Estimates of 12b-1 fees have been around $10 billion annually in recent years across all funds that charge the fee.
Where to Find the 12b-1 Fee
The 12b-1 fee is a component of a mutual fund's total expense ratio. Websites including Morningstar and Yahoo! Finance generally list the total expense ratio by fund. However, to get the most accurate and current expense ratios, it is necessary to dig into a mutual fund prospectus. The prospectus must list specific fees and charges by each mutual fund class offered.
The mutual fund prospectus will have one or more sections detailing fees and expenses. Generally, the fund's annual operating expenses will be broken down into components. The largest fee is usually the management fee, which is what the portfolio managers charge to run the fund. The distribution fee, or 12b-1 fee, will also be listed. Other fees and expenses may include sales charges such as front-end and back-end sales loads that investors incur when they buy or sell a fund. There may also be other operating expenses, such as account administration fees, recordkeeping fees and networking fees to wholesalers and other financial intermediaries that also help to sell the fund.
There are other selling fees beyond the 12b-1 marketing and promotion charges. These will be explicitly broken down and detailed in either the mutual fund prospectus or a corresponding document called a statement of additional information.
Important Considerations
Investors may question whether it is appropriate for a mutual fund to charge its existing investors a fee to market and promote the fund to other potential investors. Controversy has bubbled up from time to time over this issue, especially following the credit crisis and ensuing Great Recession that called into question many aspects of how the financial services industry operates and charges its clients.
SEC proposals at the time looked to cap the 12b-1 fee at 25 basis points and to make the fee more transparent to investors who might not even know that they are being charged for marketing, promotion and related sales activities.
The Bottom Line
Many mutual funds warrant criticism for their high fees and uneven performance. That being said, many worthwhile funds with great performance records charge very reasonable fees. In fact, 30% of mutual funds don't charge 12b-1 fees, since their managers find them unnecessary or would rather protect the financial interests of their existing investors.
To find the best funds and balance the risks against the rewards of funds that charge 12b-1 fees, investors should read the mutual fund's prospectus and SAI, and then make an educated decision over whether the fund is likely to earn a sufficient return for the fee it will charge.
FAQs
A 12b-1 fee is an annual marketing or distribution fee on a mutual fund. The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund's expense ratio. It is generally between 0.25% and 0.75% (the maximum allowed) of a fund's net assets.
What exactly are 12b-1 fees anyway? ›
12b-1 fees are often used to cover marketing and distribution expenses as well as commissions to brokers. In theory, 12b-1 expenditures can actually make a fund more attractive through economies of scale: more marketing means more investors, and more investors means less overhead per person.
How do you explain mutual fund fees? ›
Mutual fund fees generally fall into two big buckets:
- Annual fund operating expenses: Ongoing fees toward the cost of paying managers, accountants, legal fees, marketing and the like.
- Shareholder fees: Sales commissions and other one-time costs when you buy or sell mutual fund shares.
12b-1 fees are part of a mutual fund's expense ratio, which is the annual cost of owning the fund expressed as a percentage of the fund's assets. Other fees that make up the expense ratio include management fees, administrative fees, and other operating expenses.
What is the maximum 12b-1 fee that can be charged in a no load fund? ›
A mutual fund that distributes its own shares and markets itself as a no-load fund may charge a 12B-1 fee that is no more than . 25 percent.
What is the 12b1 rule? ›
In 1980, the Securities and Exchange Commission (SEC) adopted Rule 12b-1 under the Investment Company Act of 1940. This rule permits funds to compensate brokers and other financial intermediaries out of fund assets for services they provide shareholders related to the distribution of fund shares.
What is an example of a 12 b )- 1 fee? ›
The presence of a 12b-1 fee frequently pushes the overall expense ratio on a fund to above 2%. The Calamos Growth Fund is an example of a fund that carries a smaller 0.25% 12b-1 fee on its class A shares and charges the maximum 1% 12b-1 fee on its class C shares.
How do I find out the fees for a mutual fund? ›
These fees and charges are identified in the fee table, located near the front of a fund's prospectus, under the heading "Shareholder Fees." Funds typically pay their regular and recurring, fund-wide operating expenses out of fund assets, rather than by imposing separate fees and charges directly on investors.
How can I avoid mutual fund fees? ›
By employing strategies such as regularly reviewing statements, reducing trading frequency, considering alternative investments and possibly working with a financial advisor, you can optimize your investments to mitigate these fees.
What is the highest 12b-1 fee a Finra member can charge? ›
12b-1 fees – These fees, capped at 1 percent of your assets in the fund, are taken out of the fund's assets to pay for the cost of marketing and selling the fund, for some shareholder services, and sometimes to pay employee bonuses.
12b-1 fees, charged by mutual funds or exchange-traded funds (ETFs), cannot be used to cover the costs of commissions paid for executing trades in the fund's portfolio. These fees cover marketing and distribution costs but not the direct trading costs of managing the fund's portfolio.
Are 12b1 fees going away? ›
Use of 12b-1 fees has declined in recent years as the SEC has cracked down on conflicts of interest surrounding the share class. The SEC may seek to repeal the fees in the next few years, Ron Rhoades says. But some compliance experts say 12b-1 fees are better than other forms of distributor compensation.
Which of the following explains the purpose of a 12b-1 fee? ›
A 12b-1 fund is a mutual fund that charges its holders a 12b-1 fee. A 12b-1 fee pays for a mutual fund's distribution and marketing costs. It is often used as a commission to brokers for selling the fund. 12b-1 funds take a portion of investment assets held and use them to pay expensive fees and distribution costs.
Do all mutual funds have 12b-1 fees? ›
In fact, 30% of mutual funds don't charge 12b-1 fees, since their managers find them unnecessary or would rather protect the financial interests of their existing investors.
Who approves 12b-1 fees? ›
12b-1 fees get their name from the SEC rule that authorizes a fund to charge them. The rule permits a fund to pay these fees out of fund assets only if the fund has adopted a plan (“12b-1 plan”) authorizing their payment.
Which is better for most investors, load or no-load funds? ›
No-load mutual funds have no or low fees while load funds have a sales charge or commission attached. You can purchase no-load funds directly from the company or through a brokerage firm but load funds are sold through an adviser. Some studies show that no-load funds outperform load mutual funds.
Who must approve a 12b-1 fee? ›
4 12B-1 plans and any changes to their expense structuring must be approved by the fund's board of directors and amended in its prospectus filed with the Securities and Exchange Commission.
Are 12b-1 fees going away? ›
Use of 12b-1 fees has declined in recent years as the SEC has cracked down on conflicts of interest surrounding the share class. The SEC may seek to repeal the fees in the next few years, Ron Rhoades says. But some compliance experts say 12b-1 fees are better than other forms of distributor compensation.
What is the 12b-1 fee for American funds? ›
American Funds Short-Term Tax-Exempt Bond Fund Class A shares and American Funds U.S. Government Money Market Fund Class A and 529-A shares pay a 12b-1 service fee of 0.15%.
