Mutual Funds and 12b-1 Fees

If you pay any attention to your mutual funds, and you should, you'll notice that they charge a host of fees. A fund's "expense ratio" is one way to get a handle on a fund's overall annual fee bite, but it's good to poke around and get more details.

Along with the many recent mutual fund scandals and cries for reform, there's a little outrage being expressed about the 12b-1 fee. It was created in 1980 with the intent of permitting funds to charge a little money in order to cover some administrative and marketing costs. The reasoning was that by attracting more investors, the fund would become bigger and could lower its expenses by realizing some economies of scale. There's some logic in that, but it also offers some irony, in that investors are being charged a fee in order to lower their fees.

There's also a lack of logic in the fee. That's because the bigger a fund gets, the harder it often becomes for the managers to deliver market-beating results. As a fund swells to contain many billions of dollars, it's no longer able to easily make a profit on smaller companies. Even if it bought some exciting, fast-growing companies outright (which it can't do), they would still be a drop in the bucket, overall performance-wise. So when big funds charge 12b-1 fees, they're asking investors to cough up money in order to possibly make the fund perform more poorly. Oy.

Making matters even more confounding is this: Some funds that have closed their doors to new investors (often a good thing, preventing the fund from getting too big and therefore underperforming) are still charging 12b-1 marketing fees. Hmm...

Our friends at the Securities and Exchange Commission have been looking into possible abuses of the 12b-1 fee, and some reforms may be in the offing. In the meantime, take matters into your own hands and learn more about the fees your funds are charging you.

For a more in-depth introduction to mutual fund investing, look into our How to Pick the Best Mutual Funds How-to Guide, which comes with a money-back guarantee. Also, drop by our Mutual Fund Center for the scoop on funds and pointers to good ones. Our Mutual Funds discussion board is another good resource.

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