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.
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 charged to cover the expense of advertising, shareholder servicing, marketing collateral, prospectuses, and commissions paid by the issuing firm to the salesperson who sold the shares. It is deducted from the mutual fund's assets as an operational expense, driving up the fund's expense ratio.
Who approves the renewal of 12b-1 fees for a mutual fund? ›
12b-1 Fees
Any payments that a mutual fund makes for distribution must be in accordance with a written plan that must be approved by a majority of the independent directors. Both the full board and the independent directors must vote at least annually to renew the plan.
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.
What is an acceptable fee for a mutual fund? ›
A number of factors determine whether an expense ratio is considered high or low. A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
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.
How do 12b-1 fees affect mutual fund investors? ›
Here's an explanation for how we make money . A 12b-1 fee is an expense sometimes charged by mutual funds to their investors that pays for the fund's marketing and distribution costs, as well as other shareholder services. These fees frequently can be used to pay commissions to brokers who sell the fund.
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.
Are there hidden fees in mutual funds? ›
Some funds also charge a “12b-‐1 fee,” which is used to market the fund. This fee is controversial because investors, in effect, subsidize the fund's advertising at a cost to their total return. Investors may also pay a one-‐time sales commission or “load” for buying shares of a mutual fund.
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 the highest 12b-1 fees? ›
Understanding 12b-1 Funds
The SEC does not limit the size of 12b-1 fees that funds may pay, but under FINRA rules, 12b-1 fees that are used to pay marketing and distribution expenses (as opposed to shareholder service expenses) cannot exceed 0.75% of a fund's average net assets per year.
Who directly pays a mutual fund's management fees? ›
Each mutual fund and ETF pays its own operating expenses, including legal, accounting, and management expenses. The MER is the total of all expenses, expressed as a percentage of the fund's value. You can learn more about MERs in the Mutual Fund Facts or ETF Facts document.
What is the 12b-1 fee for no load mutual funds? ›
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.
Do all mutual funds have front-end loads? ›
While not all mutual funds have loads, those that do will vary depending on when the commission is paid. Front-end load mutual funds are the most common type of load funds. Let's break down how they work. A financial advisor can help you pick the right mutual funds and other assets to reach your financial goals.
How do you terminate a 12b-1 plan? ›
The Plan, or any Rule 12b-1 agreement, may be terminated with respect to each Fund at any time, without penalty, on not more than 60 days' written notice by a majority vote of shareholders of the Fund, or by vote of a majority of the Disinterested Trustees.
What is an example of a mutual fund management fee? ›
This fee is specifically for asset management services and does not include other expenses related to the fund. Typically, it's calculated as a percentage of the fund's average assets under management (AUM). For example, a fund with a 1% management fee will charge $1,000 annually for every $100,000 of AUM.
Why would mutual funds charge fees? ›
Annual Fund Operating Expenses
This is a fee charged by a fund's investment adviser for managing the fund's portfolio of securities and providing related services. This fee, if charged, is deducted from fund assets to pay marketing and advertising expenses or, more commonly, to compensate sales professionals.
What is the difference between a fee and a charge? ›
A fee can be looked at similar to a penalty. While there are no fees attached to your contract, you can be fined for late payments or a returned payment. A charge on the other hand, is an amount that you acknowledge you are purchasing. At origination, the amount you finance is considered a charge.
What is the best way to explain mutual funds? ›
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds.
