What it is:
How it works (Example):
There are generally two kinds of expenses covered by 12b-1 fees: distribution expenses and shareholder service expenses. Distribution expenses are the costs of marketing and selling fund shares, including advertising, printing and mailing of prospectuses and literature, and compensation for brokers and others who sell shares. Shareholder service expenses are the costs of employing people to respond to investor queries. It is important to note that 12b-1 fees do not always cover shareholder service expenses. Some funds pay these expenses directly out of their fund's assets. Other funds may also cover some custodial, legal, accounting, transfer agent, or other administrative expenses with their 12b-1 fees.
Mutual funds must disclose their 12b-1 fees in a fee table labeled "Shareholder Fees" in their prospectuses. Mutual funds must also disclose the expenses these fees cover in the "Annual Fund Operating Expenses" section of their prospectuses.
As with any investment costs, small fee differences can create large differences in returns over time. For example, let's assume you invest $1,000 in the XYZ Company Mutual fund, which returns 10% every year and has annual 12b-1 fees of 1%. After 10 years, you would have $23,457. However, if the fund's 12b-1 fees were only 0.10%, you would have $25,679 after 10 years--over $2,000 more. Although it is important to compare 12b-1 fees among funds, it is also important to be aware of other fund fees and a fund's total expense ratio. This is because some mutual funds may compensate for very small 12b-1 fees by charging high management, redemption, or other fees.
For more information on how fund fees can affect returns on specific investments, visit the SEC's Mutual Fund Cost Calculator at: http://www.sec.gov/investor/tools/mfcc/mfcc-int.htm
Why it Matters:
Fees and expenses vary from fund to fund, and a 12b-1 fee is just one of many fees a mutual fund may charge. A mutual fund typically pays its expenses either directly from the fund's assets or by collecting fees from shareholders, as is the case with 12b-1 fees.
The SEC generally does not limit 12b-1 fees, but the National Association of Securities Dealers (NASD) limits them to 0.75% of a fund's average net assets per year. Within this, the NASD limits shareholder service fees to 0.25% of a fund's average net assets per year.
Of all the types of mutual fund fees, 12b-1 fees are perhaps the most controversial. Some argue that 12b-1 fees are appropriate because marketing a mutual fund could increase its asset size, which would lower costs by spreading them out among more investors. Investors who avoid funds with 12b-1 fees often argue that advertising distracts management and is ineffective because it does not directly increase the fund's returns. They also note that the funds collect 12b-1 fees no matter how well it or the market performs.
It is important to note that 12b-1 fees are not part of the fee structure that determines whether a fund is classified as a no-load fund or a load fund. The NASD permits a mutual fund to call itself a no-load fund if the combined amount of the fund's 12b-1 fees and separate shareholder service fees is less than 0.25% of the fund's average annual net assets. This makes reading the prospectus even more important. In some cases, investors may actually get better returns from a load fund if a similar no-load fund's 12b-1 fees are significantly higher.