Understanding 12B-1 Funds

Investing in mutual funds can be a smart way to grow your money over time, but it's essential to understand all the fees and expenses associated with them.

One type of mutual fund that often comes with additional fees is known as a 12B-1 fund. In this article, we'll break down what a 12B-1 fund is, how it works, and why it's important for investors to be aware of these fees.

What is a 12B-1 Fund?

A 12b-1 fund is a type of mutual fund that imposes a 12b-1 fee on its holders. This fee serves to cover various expenses related to distributing and marketing the fund.

Think of it as a commission paid to brokers for selling the fund to investors. Unlike other fees, such as loads or sales fees, the 12b-1 fee is a percentage of the fund's market value.

These funds allocate a portion of the assets held to pay for these distribution costs, which are reflected in the fund's expense ratio. The fund's prospectus provides detailed information about these fees.

Often referred to as a "level load," 12b-1 fees include marketing expenses, compensating brokers and sellers, and advertising costs, such as printing and mailing fund prospectuses to investors.

Understanding the Mechanics

The name "12b-1" originates from Rule 12b-1 of the Investment Company Act of 1940. This rule permits fund companies to distribute their shares and utilise their own assets to cover distribution charges.

Distribution fees encompass various costs associated with marketing and selling fund shares, including compensating brokers, advertising expenses, and printing and mailing prospectuses.

The Securities and Exchange Commission (SEC) doesn't set a specific limit on 12b-1 fees, but the Financial Industry Regulatory Authority (FINRA) has guidelines in place. According to FINRA, 12b-1 fees designated for marketing and distribution expenses cannot exceed 0.75% of a fund's average net assets per year.

Additionally, some 12b-1 plans may include "shareholder service fees," which cover costs related to investor inquiries and providing information about investments.

These fees can either be part of the 12b-1 plan or categorised under "Other expenses." FINRA imposes an annual cap of 0.25% on shareholder service fees, regardless of whether they are included in the 12b-1 plan.

Originally intended for advertising and marketing expenses, today, only a small portion of the 12b-1 fee is allocated to these costs.

Special Considerations

In recent years, 12b-1 funds have seen a decline in popularity. The emergence of exchange-traded funds (ETFs) and the availability of low-fee mutual fund options have provided investors with more choices. Many experts view 12b-1 fees as a burden, and consumers are encouraged to explore alternatives.

With a growing array of options available, investors can find comparable funds without the additional cost of 12b-1 fees. By understanding these fees and exploring alternatives, investors can make informed decisions to optimise their investment portfolios.

In conclusion, while 12b-1 funds have been a staple in the investment landscape, their relevance has diminished in recent years. As investors become more fee-conscious and alternatives like ETFs gain traction, understanding the nuances of mutual fund fees becomes essential.

By educating oneself and exploring alternative investment vehicles, investors can make informed decisions to achieve their financial goals.