Fool's School: Those Darn 12b-1 Fees

It's a fact of life: Mutual funds charge fees. A fund's expense ratio (representing its operating expenses and management fees) is one way to get a handle on its overall annual fee bite, but it's good to poke around and learn more.

Inquirer

Published June 3, 2008, 3:01 a.m. ET

One common but controversial charge is the 12b-1 fee. It was created in 1980 with the intent of permitting funds to charge a little money in order to cover some administrative and marketing costs. The reasoning was that by attracting more investors, the fund would become bigger and could lower its expenses by realizing some economies of scale. There's some logic in that. There's some irony, too, though, since investors are essentially being charged a fee in order to lower their fees.

There's also a lack of logic in the fee. That's because the bigger a fund gets, the harder it generally becomes for the managers to deliver market-beating results. As a fund swells to contain many billions of dollars, it's no longer able to easily make a profit on smaller companies. Even if it bought some exciting, fast-growing companies outright (which it can't do), the effect would still be a drop in the bucket in relation to the fund's overall performance. So when already big funds charge 12b-1 fees, they are asking investors to cough up money in order to possibly make the fund perform more poorly. Oy.

Making matters even more confounding is this: Some funds have closed their doors to new investors (often a good thing, preventing the fund from getting too big and therefore underperforming) - but they are still charging 12b-1 marketing fees. Hmm . . .

Our friends at the Securities and Exchange Commission (SEC) have been looking into reforming the use of the 12b-1 fee. Drop by

» READ MORE: www.sec.gov

for the latest developments and for information on how to share your thoughts with the SEC.