What Is a 12b-1 Fund?
Definition
A 12b-1 fund is a mutual fund that uses part of its own assets to pay for distribution and marketing expenses. The term comes from Rule 12b-1 of the Investment Company Act of 1940, which permits funds to use their assets to cover these costs. The charges taken under this rule are commonly called 12b-1 fees. When a fund’s ongoing fee is structured this way it is sometimes referred to as a “level load.”
Why it matters
12b-1 fees reduce the return available to all shareholders because they are paid out of the fund’s assets. They are included in the fund’s expense ratio and appear in the prospectus. For investors comparing funds, understanding whether a fund charges a 12b-1 fee and how large it is can change which fund is more cost-effective over time.
Components of 12b-1 Fees
– Distribution and marketing fees: Payments to brokers or others who sell fund shares; costs of advertising and promotional materials; printing and mailing prospectuses and sales literature.
– Shareholder service fees: Payments for services to existing investors, such as answering account questions or providing account statements. These can be included in a 12b-1 plan or shown separately under “other expenses.”
Regulatory caps and limits
– FINRA caps most marketing/distribution components at 0.75% of a fund’s average net assets per year.
– FINRA caps shareholder service fees at 0.25% per year (whether inside a 12b-1 plan or billed separately).
– The SEC does not set a single numeric cap for all 12b-1 fees, but FINRA limits the specific components above.
How 12b-1 fees are presented
12b-1 fees appear in the fund’s fee table and expense ratio disclosure in the prospectus and summary prospectus. If shareholder service fees are paid outside a 12b-1 plan, they are shown under “Other expenses” rather than in the 12b-1 line.
Practical implications and criticisms
– Ongoing drag: Because 12b-1 fees are taken from fund assets, they continually reduce returns rather than being a one-time sales charge.
– Conflicts of interest: Some of the money can be used to pay commissions to brokers who recommend the fund, creating potential conflicts between investor interests and distributor compensation.
– Market trend: The industry has moved toward lower-cost vehicles (including ETFs and no-load index funds). Many investors can find alternatives with lower or no 12b-1 fees.
– Use of funds: Although Rule 12b-1 was originally designed to fund advertising and marketing, much of the budget can go to distribution commissions and intermediary payments rather than broad consumer advertising.
Quick checklist for investors comparing funds
– Does the fund charge a 12b-1 fee? Check the prospectus fee table.
– How large is the fee (annual %)? Note whether it’s part of the expense ratio.
– Is there a separate shareholder service fee listed under “Other expenses”?
– Are there lower-cost alternatives (no-load share classes, ETFs, index funds) with similar exposure?
– Consider the impact over your intended holding period; annual fees compound.
– Confirm whether the fee pays ongoing distribution commissions to brokers (look for “level load” language).
Worked numeric example
Assume two share classes of a stock mutual fund offer identical investment portfolios:
– Class A: expense ratio excluding 12b-1 = 0.60% per year; 12b-1 fee = 0.50% per year → total expense ratio = 1.10% per year.
– No-Load Class: expense ratio = 0.60% per year; no 12b-1 fee → total expense ratio = 0.60% per year.
If you invest $10,000 and the fund’s gross return before expenses is 6.0% annually, approximate net returns after fees for one year:
– Class A: net return ≈ 6.0% − 1.10% = 4.90% → ending value ≈ $10,490.
– No-Load Class: net return ≈ 6.0% − 0.60% = 5.40% → ending value ≈ $10,540.
Difference after one year = $50. Over many years the gap widens because the extra fees compound; that’s why even small annual fee differences matter.
Special considerations for advisors and brokers
Funds sometimes offer multiple share classes with different fee structures to accommodate different distribution channels. Broker-sold share classes may include 12b-1 fees to compensate the intermediary. If you use a financial professional, ask how they are compensated and whether their compensation is tied to 12b-1 fees.
Where to find authoritative information
– Read the fund’s prospectus and its shareholder reports—the fee table shows exactly how 12b-1 and other expenses are charged.
– Check regulatory filings (Form N-1A for mutual funds) for detailed disclosures.
Selected references
– U.S. Securities and Exchange Commission (SEC) — Mutual Fund Fees and Expenses: https://www.sec.gov/reportspubs/investor-publications/investorpubsmutualfundshtm.html
– Financial Industry Regulatory Authority (FINRA) — Mutual Fund Expenses: https://www.finra.org/investors/alerts/mutual-fund-fees-and-expenses
– Investopedia — 12b-1 Fee Definition: https://www.investopedia.com/terms/1/12b-1-fund.asp
– Vanguard — How mutual fund fees affect returns: https://investor.vanguard.com/investing/fees
Educational disclaimer
This article is for educational purposes only and does not constitute investment advice, a recommendation, or an offer to buy or sell securities. Consider consulting a qualified financial professional and read a fund’s prospectus before investing.