12b-1 Fees Warning
Some mutual fund companies have put a hidden trap that you should be aware of when deciding to invest your money, namely 12b-1 fees! They represent one of the darkest secrets, which you should become especially proficient in detecting and avoiding.
12b-1 Fee Origins and Essence
In 1980 the Securities Exchange Commission (SEC) permitted the 12b-1 fees. They were first mentioned in 1940 in the Investment Company Act where the mutual funds were first authorized to cover their expenses and distributions from their capital, thus alleviating the burden of the funds.
This fee action was undertaken in order to encourage investing in mutual funds. In a way, 12b-1 fees promoted economies of scale since part of the collected money were allocated for marketing. This in turn leads to asset boost and lower annual operational expenses by attracting more investors and enjoying the opportunities of the economies of scale.
12b-1 Big Misleading!
The only people that enjoy the fruits of 12b-1 fees are fund brokers, not investors!
By law the 12b-1 fee is 1% annually from which 0.25% allocated for brokers. In reality, as little as 5% goes for promoting the mutual fund to outsiders, whereas as much as approximately 60% goes into fund broker's pockets for the "well-done" job. What is worse is the fact that several closed funds still burden their investors with 12b-1 fees, which is absolutely unnecessary since this type of funds are not open to outsiders. Therefore, compensating brokers is totally pointless.
Usually, mutual fund managers apply 12b-1 fees as a concealed load on your investment. When advising with a fund manager s/he may offer you different versions of one and the same fund, but often they do include loads. A typical illustration of this is the case of charging up front 3% for a Class A share, whereas a Class B is burdened with a fee only after the sale of the shares during the first years of ownership. But be careful! Do not be enticed by the Class B investment since it includes a concealed 12b-1 fee! In the long run, it will represent a less profitable choice, because it will exhaust your returns even more that a Class A investment. Since it looks like a load free opportunity, many brokers succeed in selling this version to employers, who provide their employees with a 401k plan.
12b-1 Fee Avoidance Tricks
Here are some ways by which you can evade 12b-1 fees:
- Purchase no-load funds!
This first method of avoiding paying 12b-1 fees has its drawback. Mutual funds can classify themselves as load free even if they charge an annual 12b-1 fee of 0.25% or less. However, you can still search for 100% no load funds, which are also called true no-load funds. They represent funds that do not burden their investors with whatsoever 12b-1 fees.
- Always carefully read the fund's prospectus!
By law, all mutual funds are required to provide the prospective and existing investors with a prospectus, in which information about all services and fees is included. Additionally, the SEC has made it obligatory for the mutual funds to specify the impact of the fees on your invested resources. Cautiously check the details in the "12b-1" category and compare them with the offers of other funds.
- Use quote services!
This is an online service that provides you an easy access to mutual funds' 12b-1 fees and allows for a quick comparison.
Finally, always do your best in circumventing 12b-1 fees, since they not only take money away from you, but also represent an unjustified expense that don't bring any benefits to you!
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