What Is a 12b-1 Fee on Mutual Funds ?
A 12b-1 fee is a marketing and distribution fee charged by mutual funds to their investors. This fee is paid out of the fund's assets.
Historically, this fee ranged anywhere from 0.25% to 1%. However, with the continued poor market environment for mutual funds it has fallen considerably in recent years and may soon disappear all together.
Generally, 12b-1 fees cover two kinds of expenses relative to an investor's mutual funds. These are distribution expenses and service expenses.
Distribution Expenses
These expenses refer to expenses such as marketing and selling fund shares, delivering shareholder materials, and providing the toll-free phone number.
Distribution expenses are limited to 0.75% out of the total 1% capping for 12b-1 fees.
Service Expenses
These expenses refer to activities that benefit fund investors such as compensating plan managers who look after their mutual fund accounts.
Service expenses are capped at 0.25% annually.
How 12b-1 Fee on Mutual Funds Work
When money is invested in a mutual fund, the manager of that mutual fund has to make many marketing and distribution expenses which are paid for by the investors in this fee.
These fees are used to cover things like creating prospectuses, creating sales literature, advertising, printing costs associated with these materials and marketing costs to attract new investors.
Who Pays the 12b-1 Fee?
The expense is paid out of the assets in a fund and thus it is not deducted from the yield or return on investment for each investor.
When expenses go up, so does this fee since it is charged as a percent. Some studies have shown that the 12b-1 fee is usually equal to 1% of assets invested.
Examples of When 12b-1 Fee on Mutual Funds Would Be Applicable
12b-1 fees are paid by investors in mutual funds for almost any type of fund, including money market funds. The only exception might be sector or other specialized funds which are not marketed to the general public.
Say, for example, a mutual fund has an average annual net asset of $20 million. A company charges 1% of the net asset as a 12b-1 fee.
This means that the 12b-1 fee is equal to $200,000.
If the company caps the distribution fee at 0.75% and the service fee at 0.25%, the distribution fee is equal to $150,000 and the service fee is $50,000.
Since these fees are paid to third parties, they are not included in the published management fee for your mutual fund.
How to Avoid 12b-1 Fees on Mutual Funds?
Avoiding these fees is possible by investing in mutual funds that do not charge them.
Most mutual funds sold through brokers or investment advisors will likely have this fee attached, but thanks to increased competition in the market there are now more options for mutual funds that have no 12b-1 fee attached.
Here are some options to consider to avoid the 12b-1 Fee.
Low-Cost Online Broker
One way to avoid paying these fees is by investing with a low-cost online broker where funds have no distribution or service fees.
Dollar-Cost Averaging
Another strategy you can use is dollar-cost averaging, which lets you buy shares at regular intervals throughout the year so you do not need to pay for another transaction.
Expense Ratio
Also, consider looking at a mutual fund's expense ratio. The mutual fund's prospectus will detail the fund charges for distribution and service expenses. Make sure you understand how they affect your return.
Benefits of Mutual Funds With a Lower 12b-1 Fee
Not only can you avoid having to pay this fee, but mutual funds with lower 12b-1 fees tend to yield better returns on investment for investors.
This is because the money saved from avoiding these fees can be reinvested in the fund itself instead of being given to a third party. This can have a dramatic impact on how much money you would make with your mutual fund.
Here are some examples to illustrate why this happens.
For example, say you invest $10,000 in a mutual fund that yields 6% per year and has 2% in expenses. If there is a 1% 12b-1 fee, you would make $600 in return for the year.
However, if the fund had half that amount in fees - 0.5% – and yielded 5%, – your return would be $2,500 after 12 months.
This is why investors should always check for what fees are attached to their mutual funds before investing.
The Bottom Line
When it comes to your money, all expenses matter, including 12b-1 fees on mutual funds.
Before you invest in a mutual fund, learn how much this fee is and whether you can avoid paying it by investing in a low-cost online brokerage or mutual fund without 12b-1 fees attached.
If you do have funds that take away from your returns through high 12b-1 fees, remember that there are always other options available.
Contact a financial advisor or broker who can suggest low-fee alternatives for you.
FAQs
1. What is a 12b-1 fee on Mutual Funds?
A 12b-1 fee is an annual marketing and distribution fee the fund collects to compensate the broker or salesperson who sells the mutual fund. It is usually expressed as 1% of assets sold.
2. How does the 12b-1 fee work?
The 12b-1 fee is expressed as a percentage of assets sold, which means it has little effect on long-term investors. The fee becomes larger for investors who buy and sell frequently, especially if they use a broker who gets paid through 12b-1 commissions.
3. Who pays the 12b-1 fee?
Since the fee is generally not a flat dollar amount, it is included in the fund's expense ratio. In other words, when you invest in a mutual fund that charges 12b-1 fees, you pay for them indirectly through reduced returns on your investment.
4. Examples of when the 12b-1 fee would be applicable?
If you decide to sell all your mutual fund holdings in a given year because you need money, you will likely pay the fee. However, if you keep your investment in that same mutual fund for 10 years or longer, that fee might be irrelevant.
5. How to avoid paying the 12b-1 fee?
You can avoid 12b-1 fees by buying no-load mutual funds through an online brokerage firm or without any additional commissions charged. You should always read a fund's prospectus to learn about its 12b-1 fee structure.
