12b-1 Fee Caution
E-Trade responded to the tight inspection on the fees of mutual funds by offering its clients a 50% rebate on the 12b-1 fee. Being the pioneer company to offer such a service, E-Trade flooded the Internet with myriads of advertisements calling for becoming part of their funds and benefiting from these lower fees. If you get excited by the offer of having 50% of your 12b-1 fee back into your account, then you have become an easy catch in something we consider a scam.
E-Trade announced an offer of rebate of the 12b-1 fee which accounted for 50% of the amount. They continue by explaining that this type of fees is used for marketing purposes and are also applied in the sale of funds shares.
E-Trade provides a detailed list that includes the names of all funds they offer with 12b-1 fee. An approximate estimation of the rebate you will receive if you decide to purchase a particular fund is provided.
What is behind it?
We truly hope that E-Trade is governed by some noble feeling of alleviating the burden on the investors. This rebate technique was undertaken after the increased control of the industry regulators, the congress and the media. Having noticed this trade, the top managers of the company embarked on this endeavor of paying back a portion of the 12b-1 fee, becoming the first brokerage to ever do this. Fortunately, we can be difficultly fooled.
No need for 12b-1 Fees
The reality is that 12b-1 fees were introduced by the SEC in order to encourage mutual fund activity. This was done mainly by the transference of the marketing and other administrative costs financing from the fund to its shareholders. But the mere fact that today there are more funds than stocks leads to the conclusion that such encouragement is no more needed. Therefore, the need for 12b-1 fees is eliminated.
Many companies justify the charge of 12b-1 fees with the need of having enough resources to attract new investors. These new investors are needed in order to benefit from the economies of scale so that the cost of managing the fund is reduced. But the truth is that, only 5% of the fee goes for this purpose, whereas the other portion goes directly to the broker's wallet, who has managed to attract your money to the fund. What is even more interesting is that many closed funds continue to collect the 12b-1 fee, even though new investors cannot purchase shares of the fund.
No matter what the broker tells you, you benefit in no way from paying the 12b-1 fee. Your investment will not suffer only the broker's wallet. So do not be wary to invest in 12b-1 fee free funds, since they are not worse than their fee counterparts. Do not burden your financial portfolio with a yearly payment that will not bring any advantage to your investment.
Bad 12b-1 fee Support
What E-Trade actually does is not good either for the investors or the fund companies. They encourage something that should be abolished. This argument can be supported by the way E-Trade has structured its offer and supplementing clarifications. The fact that they provide a list of mutual funds that charge 12b-1 fees and an estimation of the corresponding rebate amount, leads to the logical conclusion that the company tries to encourage the purchase of loaded funds. E-Trade tries to win your confidence by explaining in great details how much you will get back and for what purposes the rest of the money will be used.
Still, it is not very difficult to do the calculations. If you invest in a load-free account, you will keep your investment intact. But if you decide to invest in a loaded fund, you will not only lose part of your investment due to the 12b-1 fee, but also your loaded fund will continue to charge you 1% annually and will give you back just 0.5% (which on the top of everything will be charged with taxes).
E-Trade tries to justify its policy by claiming that they have always been in the best service of their clients, by guarding their interests on the market. What's more, they defend themselves by claiming that they have greatly contributed to the development of both online investing and different technologies that have in turn led to the reduction in their costs.
Finally, we would like to stress that we do not have anything against E-Trade. What we object is the purchase of loaded funds, which provide no benefit to the investor. It is true that current E-Trade investors that already pay 12b-1 fees are experiencing good returns, but they should not be misled into moving to funds where they are required to pay even higher fees. A more professional advice will be to transfer their money into no-load funds, where they will not have to lose their money and then have only half of it back.
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