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Wealth Management Wire

12b-1 Fees: It Is Time To Bid Them Farewell?

The 12b-1 fee isn't living up to its promise of helping to scale up and bringing down the expense ratio as the mutual fund grows.

From its start in 1980, the 12b-1 fee was controversial – a distribution charge assessed against current mutual fund investors, that the fund company can use to market the fund to new investors. In other words, the mutual fund got to use investor dollars (rather than its own money) to grow the fund’s assets under management (AUM).

In theory, this use of the mutual fund investor’s own money to market the fund company’s products was supposed to be good for the investor, because it would help grow and scale the fund and bring down its operating expense ratio. However, several decades later, subsequent analysis is finding that while mutual funds that charge 12b-1 fees are successful at incentivizing salespeople to bring in more assets under management, the 12b-1 fee isn’t living up to its promise of helping to scale up and bringing down the expense ratio as the mutual fund grows.

At the same time, the reality is that investor behaviors are shifting as well. A growing number of consumers are purchasing their investments directly, avoiding the 12b-1 fee altogether by eliminating the mutual fund salesperson middleman. And as more and more financial advisors become affiliated with an RIA firm and get paid an AUM fee on an advisory account, the 12b-1 fee is less and less of a driver to incentivize financial advisors anyway.

In fact, the entire shift of financial advisors from being mutual fund salespeople (compensated by upfront commissions and ongoing 12b-1 fees) to operating as actual financial advisors instead (compensated by fees directly from their clients) raises the question of whether the 12b-1 fee is still relevant at all. Especially given the 12b-1 fee’s controversial roots, and the misalignment it creates between who pays the marketing and distribution costs, and who actually benefits from it.

Of course, the reality is that financial advisors, custodians, broker-dealers, and product providers still need to get paid for what they do, which means eliminating the 12b-1 fee still won’t necessarily bring down costs for the end client. Instead, it would likely just shift where and how financial advisors and their platforms get paid. Nonetheless, given the 12b-1 fee’s implicit conflicts, and their declining relevance, arguably it’s time to create a more appropriate pricing structure for the realities of today’s investment marketplace!

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