12b-1 fee

Is there any reason to choose a mutual fund that levies a 12b-1 fee? For example, can I expect a fund with a 12b-1 fee to outperform a similar fund that does not charge the fee?

Approximately 70% of mutual funds (measured by share class) levy a 12b-1 fee, so the results of any thorough search or screen are sure to include solid investment candidates both with and without 12b-1 fees. Keep in mind that the presence of a 12b-1 fee does not necessarily indicate a more expensive fund. A fund that charges a 1% management fee plus a .25% 12b-1 is still less expensive than a fund without a 12b-1 that charges 1.5% in other fees. Originally enacted in 1980, the 12b-1 fee was intended to help a then-struggling mutual-fund industry defray marketing and distribution expenses. However, the proliferation of share classes has increasingly blurred the lines between 12b-1 fees and sales loads. Some funds still offer just one share class, but many offer five or more. As of this writing, there are approximately 8,200 U.S.-based mutual funds, and the many with multiple share classes produce over 22,000 total variations. It is within these share classes that the issue of 12b-1 fees gets opaque. Exploring a few of the most common share classes (A, B, C) can illuminate the issue. In general, A-share funds (including load-waived A shares and even some no-load funds) have 12b-1 fees equal to 25 basis points ( ¹/₄ of 1%) of the fund's assets on a yearly basis. B and C shares do not carry a front-end sales load (often 4% to 5.75%) like traditional A shares, but the 12b-1 on B and C shares can be as high as 1%. At that level, the 12b-1 can start to rival the other internal costs of managing the fund. I wouldn't be overly concerned with a 25-basis-point 12b-1, as it wouldn't take much for a skilled asset manager to overcome that hurdle and still add value on a net basis. I would be more hesitant to saddle that same manager with a 100-basis-point additional fee—especially if it was permanent (most B shares eventually exchange for lower-cost A shares in six to ten years, but C shares can impose the fee indefinitely). Ultimately, having many choices can improve your end result, but you should explore each option fully and choose the one that is most closely aligned with your interests and objectives.

Noah L. Myers, CFP^®, Principal and Chief Investment Officer, MiddleCove Capital, Centerbrook, CT