After three straight years of knockout stock market gains, you probably haven’t noticed the notorious 12b-1 fee at work. Yes, you may have caught on that fund fees now average 1.5% of your invested savings, and perhaps you’ve even grasped the difference between a front-end and back-end load down cold (see “Nothing Comes Free,” Moneywise, May 1998). While those charges are pretty easy to spot and compare from fund to fund, the 12b-1 is a sneakier fee that might creep up on your mutual fund investment and catch you unawares.
It’s also why the 12b-1 has caused its share of controversy. Named after a rule the Securities and Exchange Commission (SEC) passed to allow fund companies to use it, the 12b-1 is now charged by over half of all mutual funds. On the surface, it’s meant to pay for a host of items, including marketing and advertising costs such as sending out pamphlets and prospectuses. Mutual funds used it as an incentive, a way to woo brokers and financial planners for pushing their investment over others that might not pay the fee. The 12b-1 fees also pay for so-called distribution-related expenses such as printing and mailing reports to shareholders.
The fact of the matter is, you could very well be stuck with a 12b-1 fee, yet not be aware of it. Funds that charge fees when you purchase or sell shares are easily distinguishable in the industry: they’re listed as “load” funds. But don’t be fooled into thinking that all no-load funds shun 12b-1 fees. Michelle Smith, managing director for the Mutual Fund Education Alliance based in Kansas City, Missouri, notes that a fund can charge a 12b-1 fee of up to 0.25% and still call itself “no-load.” Even though this is a relatively low fee, says Smith, the trick is to choose one with an even lower fee scale. However, some critics say 12b-1 fees are nothing more than a disguised “load” or sales fee.
Given that the stock market has logged three great years, and knowing that the average 12b-1 fee is 0.5% for stock funds and 0.35% for bond funds, according to Lipper Analytical Services Inc., your first tendency might be to write it all off. Don’t. Annual 12b-1 fees can run as high as 1% of a fund’s assets. According to Olivia Barbee, an analyst with Morningstar, the Chicago company that tracks the mutual fund industry, over a ten-year period with stocks gaining about 10% annually, forking over a puny 1% each year will shave a full $2,300 off every $10,000 you put into a mutual fund. What’s more, 12b-1 fees have risen sharply in recent years. In 1995, the typical 12b-1 fee was 0.31% for equity funds and 0.26% for fixed-income funds.
When they were first introduced in the early 1980s, 12b-1 fees were touted as a boon to fundholders. The thinking was that by increasing the number of investors and thereby realizing economies of scale, 12b-1 fees would lower overall fund costs. They haven’t, say industry experts.