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12b-1 Fees and Loads Harm Illustration

In order to better exemplify the negative impact of 12b-1 fees and loads on your investment consider the following scenario.

The Offer

You are considering the investment in a "Fund X" and its broker offers you two options:

  1. Class A, which includes shares burdened by a front-end load of 3%. This means that when you purchase the shares you are immediately charged a fee. But this charge does not represent a 12b-1 fee.
  2. Class B in which you are not charged any fee as long as you keep the shares for 3 or more years. On the other hand, if you decide to sell the shares during the first year, you will be subject to a 2% load. The load is reduced to 1% as long as you sell the shares during the second year.

There is a third option, "Fund Y" with no load and no 12b-1 fee, but your broker does not inform you about it.

Your Choice

You have decided to keep the shares for 7 years. Therefore, you are most attracted by the second offer. Unfortunately, the broker has "accidentally" missed to inform you that Class B charges 12b-1 fee. The amount of this fee is 1% that is charged annually. But since this information is listed in the prospectus, we cannot blame the broker. It is up to you to check such details.

The Consequences

In the seventh year of your investment, naturally Fund Y (the one that your broker didn't tell you about at all) has a greater value than both classes of Fund X. But let's concentrate on Class A and Class B options. When deciding on the parking place of your money, you were attracted by the Class B alternative since it didn't have any fees as long as you hold it for 7 years. But you have failed to take under consideration the 12b-1 fee that was announced on the prospectus. This fee has resulted in lower returns on your investment, since it represents an annual charge of 1%. It has exhausted your returns, thus resulting in a worse choice than the Class A option with its one-time 3% up front charge.

Important Conclusions

Firstly, always check the mutual fund's prospectus about information that your broker may have "failed" to provide. And secondly, what seems more profitable is not always the best choice since it may hide its traps that eventually may deplete your returns.

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