What Is a 12b-1 Fund?
Let me explain what a 12b-1 fund is: it's simply a mutual fund that charges you, the investor, a 12b-1 fee to cover its distribution and marketing costs. This fee often serves as a commission to brokers who sell the fund to you.
In these funds, a portion of your investment assets gets allocated to pay for these fees and distribution expenses. You'll find these costs baked into the fund's expense ratio, and they're detailed in the prospectus. Sometimes, people call 12b-1 fees a 'level load' because they're ongoing rather than a one-time charge.
Key Takeaways
- A 12b-1 fund includes a 12b-1 fee that pays for the fund's sales and distribution costs.
- This fee is calculated as a percentage of the fund's market value, unlike upfront load or sales fees.
- It covers marketing, selling shares, compensating brokers, advertising, and even printing and mailing prospectuses to investors.
- These funds were once popular but have seen declining interest with the rise of ETFs and low-cost mutual funds.
Understanding 12b-1 Funds
The term 12b-1 originates from Rule 12b-1 in the Investment Company Act of 1940, which permits fund companies to distribute their own shares. This rule allows them to use the fund's assets to cover distribution charges.
Distribution fees encompass payments for marketing and selling shares, such as compensating brokers and sellers, plus advertising costs like printing and mailing prospectuses to new investors or sales literature. The SEC doesn't cap these fees, but FINRA limits those used for marketing and distribution to 0.75% of the fund's average net assets annually.
12b-1 Fees
Some 12b-1 plans include 'shareholder service fees,' which pay for responding to your inquiries and providing information about your investments. A fund can charge these without a formal 12b-1 plan, but if they're part of one, they'll appear in the fee table under that category.
If paid outside a 12b-1 plan, these fees fall under 'Other expenses.' FINRA caps shareholder service fees at 0.25% annually, whether or not they're in a 12b-1 plan. Originally meant for advertising and marketing, today only a small portion of these fees actually goes there.
Special Considerations
You should know that 12b-1 funds have lost popularity lately. With the explosion of exchange-traded funds (ETFs) and low-fee mutual funds, investors like you have plenty of choices. Experts often see 12b-1 fees as dead weight—unnecessary costs that you can avoid by shopping around for similar funds without them. Remember, the maximum 12b-1 fee for distribution is currently 0.75% of net assets.
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