What Are 12b-1 Fees in Mutual Funds?

12b-1 fees are annual marketing or distribution fees on mutual funds. It was made legal after the introduction of the section of the Investment Company Act of 1940. They are included in a mutual fund’s expense ratio and deducted from its assets, impacting overall returns. Typically, 12b-1 fees cover advertising, sales commissions, and other costs related to marketing the fund to investors. These fees can influence the choice of funds, particularly for cost-conscious investors. 
 

Understanding 12b-1 Fees 

12b-1 fees are charges included in mutual funds primarily for distribution and marketing purposes. Their main objective is to promote the fund and attract new investors. By covering costs such as advertising, sales promotions, and payments to brokers, these fees aim to enhance the fund’s visibility and accessibility in the market. 

Understanding 12b-1 fees is crucial for investors as they directly impact the fund’s expense ratio and the net returns. While these fees can help grow the fund’s assets and potentially reduce other costs, they also reduce the overall returns for investors. Therefore, evaluating the impact of 12b-1 fees is an essential step in selecting a mutual fund. 

 

12b-1 Fees Breakdown 

 

The 12b-1 fee is divided into two components: the distribution and marketing fee, and the service fee.  

Distribution and Marketing Fee 

This portion of the 12b-1 fee is generally capped at 0.75% annually and covers costs associated with advertising, marketing, and promoting the mutual fund.  

Service Fee 

The service fee, generally capped at 0.25% annually, is used to compensate brokers and other professionals for providing ongoing services to fund investors.  

 

How to Avoid 12b-1 Fees 

 

Fortunately, not all mutual funds charge 12b-1 fees. Many low-cost index funds have annual fees under 0.25%. To reduce 12b-1 fees, consider the following techniques: 

Research about Mutual Funds 

When selecting mutual funds, look for those with low overall expense ratios. The expense ratio includes 12b-1 fees along with management fees, administrative fees, and other operating expenses. Mutual funds are required to disclose these fees in their prospectus under the shareholder fees section. 

Consider Alternatives 

Investors might also consider exchange-traded funds (ETFs) or passively managed mutual funds, which generally have low expense ratios due to the absence of active management. These funds track specific indices and often present a cost-effective alternative to traditional mutual funds with high 12b-1 fees.