Why 12b-1 Fees Are Evil!

January 31, 2007

First off, what’s a 12b-1 fee? According to Investor Words, a 12b-1 fee is:

An extra fee charged by some mutual funds to cover promotion, distributions, marketing expenses, and sometimes commissions to brokers. A genuine no-load fund does not have 12b-1 fees, although some funds calling themselves “no-load” do have 12b-1 fees (as do some load funds). 12b-1 fee information is disclosed in a fund’s prospectus, is included in the stated expense ratio, and is usually less than 1%.

So, 12b-1 fees cover promotion, distribution, marketing expenses, and sometimes commissions to brokers. None of these, aside from broker compensation, add value to the existing shareholders. That’s what is evil about 12b-1 fees.

How much are 12b-1 fees?

A 12b-1 fee is usually 25 basis points (.25%) and is charged annually. Doesn’t sound like much does it? Well, believe me, it adds up! Take a look at the following graphic. The first one is for a one-year time period. The second graphic is for a 10-year time period.

12b-1 Fees

12b-1 Fees

As your account value grows, the 12b-1 fee (which is a percentage of your account value) grows too. Over the long-term it can really add up.

That’s not all, the better rate of return you get, the more you pay in 12b-1 fees as this graphic shows:

12b-1 Fees

To arrive at these numbers, I assumed an investment of $100,000. I then ran the numbers without a 12b-1 fee to get an end result. Then I ran the numbers again minus the 12b-1 fee and subtracted that result from the first result. Make sense? Basically, I used the same method as the first two graphics, but arranged the results differently for easy comparison.

The bottom line

In my opinion, 12b-1 fees do not add value unless they are used to compensate a broker (as long as that broker is earning it). If you are investing on your own through no-load mutual funds, then I would think twice before buying a fund with a 12b-1 fee. Of course the choice is yours. After all, it is your money.

Trackbacks and Pingbacks:

  1. » Weekly Roundup - 02/02/07 @ fivecentnickel.com - February 2, 2007

    […] JLP explains why 12B-1 fees are evil. […]

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  3. AllFinancialMatters » Blog Archive » Not All S&P 500 Index Mutual Funds Are Created Equal! - February 14, 2007

    […] These numbers really shouldn’t surprise us. The main reason the first two classes are so much more expensive is that they have higher 12b-1 fees to compensate the broker. Eventually the back-end load mutual fund will revert to the same management fee schedule as the front-end load mutual fund, which will mean lower fees. What I found interesting was the fact that the no-load class was actually cheaper on average than the institutional class. The level load fund will remain the same for as long as the mutual fund is owned. […]