The recently passed financial reform bill improves the status quo, but it still leaves a lot to be desired. Among other areas left wanting, the new law's curtailment of mutual fund 12b-1 fees may not benefit you as much as you'd hope.
Mutual fund companies created the 12b-1 fee to cover the expenses they incurred in marketing and selling funds to investors. That serves the fund company well, since every dollar they take in generates additional fees. But it's less beneficial for investors; the bigger a fund gets, the harder it can be for its managers to find enough great investments.
The change
Think of American Funds' massive Growth Fund of America, holding more than $140 billion in assets. Class A shareholders pay a sizable one-time 5.75% sales load to get in, plus an annual expense fee and a 12b-1 fee of 0.25%, for a total annual fee of 0.75%. Class-C shareholders pay annual 12b-1 fee of 1%, plus an administrative fee, for a net annual fee of around 1.49%.
Investors who own and hold class-C shares for 10 or 15 years will probably pay more in the long run than A-class owners. It's kind of ridiculous to still be compensating the outfit that sold you a fund after a decade or more. The new regulations will limit 12b-1 fees to 0.25%, and will cap the cumulative 12b-1 fees that can be levied in any of a fund's classes so that they don't exceed the biggest sales load -- 5.75%, in this fund's case. The law also requires funds to more clearly label and explain fees.
This move will likely shrink the income of mutual fund players such as Fidelity, Legg Mason
If you're invested in these companies, don't start worrying just yet. They may just shift some of their fees into other categories under different names, so that they make up some or all of the shortfall elsewhere. The advisors who earned money from sales commissions may start charging flat fees for their services instead. Some might lose interest in selling mutual funds to customers and focus more on less suitable but more lucrative products, such as variable annuities. This may be good for investors in financial companies, but it can hurt customers seeking effective places to park their money.
Be vigilant about the fees you're being charged, and know whether you're getting an appropriate and effective product in exchange. You can learn more and share your comments with the SEC at its website -- just click on the "Mutual Fund Distribution Fees > Confirmations" section.
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