Stop This Dumb Fee Once and for All

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With all the uncertainties that come whenever you make an investment, there's one thing you can be sure of: Every dollar that goes toward paying fees and other investing costs is one less dollar in your pocket. It always makes sense to eliminate unnecessary fees because it leaves you with more money in your pocket.

That's the reason why The Motley Fool has paid so much attention to the latest efforts from the Securities and Exchange Commission to rein in so-called 12b-1 fees. These fees, which nominally go toward sales and marketing costs, represent just one more way in which some fund companies and financial advisors engage in compensation practices that can stand in the way of their customers getting the treatment they deserve.

Let the scare tactics begin
As you'd expect, though, comments from the mutual fund industry have largely come in against the proposed SEC reform. Consider the following arguments made by various fund companies and trade associations:

  • The Investment Company Institute, which is the mutual fund industry's trade association, argues that the SEC proposal would actually lead to higher costs for fund shareholders and that any benefits would be minimal.
  • BlackRock (NYSE: BLK  ) is one of the largest managers that offer C shares -- a class of mutual fund shares that typically imposes a 12b-1 fee as high as 1% annually. It argues that one of the only ways small investors can gain access to professional investing guidance is through the incentives that C shares pay to financial advisors.
  • AllianceBernstein (NYSE: AB  ) points out that the rules could adversely affect Class R fund shares, which are designed for employer retirement plans. Without 12b-1 fees, fund companies may find it no longer cost-effective to offer those shares to small employers, effectively locking them out of 401(k)s and other worker retirement plans.

From these comments, you'd think that the mutual fund industry would come to a screeching halt without unfettered 12b-1 fees. In reality, though, the rule change would simply force fund companies and financial advisors to be more obvious about the way they charge for their services.

Goodbye and good riddance
Let's start with C shares. Many companies, including Franklin Templeton (NYSE: BEN  ) , Goldman Sachs (NYSE: GS  ) , and Janus Capital (NYSE: JNS  ) , offer C shares that impose substantial 12b-1 fees on clients. Some of the money collected from those fees goes to the financial advisors who sell fund shares to their clients.

But why should it be the job of a fund company to collect compensation for a financial advisor? Many advisors state their fees in an upfront manner, rather than relying on back-room compensation arrangements in exchange for steering clients toward certain investments. In many cases, you'd be better off paying a fee-only financial advisor for advice combined with the best investments that fit that advice, rather than having a commission-based advisor take money from underperforming funds that happen to have 12b-1 fees.

The argument is even stronger for R shares and 401(k) plans. Retirement plans are supposed to be an employee benefit, not a chance for fund companies to take advantage of workers whose employers refuse to pony up for 401(k) investment options that don't impose 12b-1 fees. And again, companies like AllianceBernstein, JPMorgan (NYSE: JPM  ) , and Invesco (NYSE: IVZ  ) that charge 12b-1 fees on some retirement plan funds have a captive audience whose only choice other than to pay those fees is not to participate in the most valuable tax-deferral opportunity most people ever have.

Get everything on the table
The real issue behind the SEC proposal is that Wall Street firms are convinced that the investing public would never pay them anything close to the compensation they receive if the public had to actually write a check for the fees they pay. The SEC's proposed rules don't go anywhere near that far, but they are a step in the right direction -- and perhaps a step that will make more investors take notice of just how much money goes toward services they may never use.

What do you think about 12b-1 fees? Chime in by saying your piece in the comments section below.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger doesn't deal well with dumb fees. He doesn't own shares of the companies mentioned in this article. BlackRock is a Motley Fool Inside Value choice. The Fool owns shares of JPMorgan Chase. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy wants you to keep more of your money.

Read/Post Comments (5) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 15, 2010, at 2:10 PM, mrwizard555 wrote:

    i would rather pay a front end load and get smacked once.

  • Report this Comment On November 15, 2010, at 2:28 PM, dboydb wrote:

    I have always been a fan of Vanguard's way--low fees everywhere. Not to mention that index funds routinely beat the return posted by many "actively managed" funds.

    High fees are the equivalent of government employment or university tenure--you get paid without reguard to how well you do.

    Companies need to offer the maximum number of choices--those employees who inform themselves will do better than those who remain ignorant.

  • Report this Comment On November 16, 2010, at 3:57 PM, dfrizzle03 wrote:

    @ mrwizard555

    what would you do if you bought class A shares, the ones with a front-end load, and then realized that the fund your holding is not performing well?? would you dump the existing fund and go get another, incurring the large front-end fee all over again???

    class C shares, the 12b-1 fee shares, offer flexibility and monetary mobility for investors who are seeking to obtain the greatest return within the mutual fund universe. they really aren't as bad as they seem, they have just been thrown in the same boat as the ridiculous credit card fees and other fees that large banks charge.

  • Report this Comment On November 17, 2010, at 1:17 PM, mikebaris wrote:

    Buy and hold is dead --

    Dan Caplinger is a Talking Head!

    12B-1 fees are an inexpensive way to create a portfolio for a client. The only alternatives are Front load A shares , Wrapped accounts which will cost about 50bps more OR trade low cost ETFs/Stocks which most investors will blow themselves up.

    My belief is that fees are only an issue in the absence of value

    Why get rid of the least expensive option for many clients?

  • Report this Comment On November 28, 2010, at 10:03 AM, jargonific wrote:

    For a company like Blackrock that is imposing the fees and offering C shares --- How can the small investor know for sure what their agenda is for promoting these shares? Is it to make the fees or because they truly see a lot of growth in the future?

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