Corporate Governance

Mutual Fund Distribution Fee Reform, Part II

By Jennifer S. Taub

Sales commissions and other marketing fees associated with buying a share in a mutual fund differ from buying a stock or bond of a public company.  For example, if I called my broker and placed an order to buy 100 shares of Company A stock at $100 per share, the broker would charge me a commission for that purchase.  Let's say my broker charges $7.95 for the trade if I executed it online, or $32 if I ask for a live person to assist me.  Thus, if I used live help, I would need to send $10,032 to settle the trade. Then I'm done. My broker does not charge me annually a marketing fee associated with that initial sale.

In contrast, if I buy a mutual fund from my broker, the fees can be larger. There might be a 4% fee up front. Returning to that $10,000 investment, I might pay between $400. Or, if not, I might pay a similar exit fee.  Or, I might be charged about 3/4 of a percentage point, so about $75 per year (and more if the fund assets appreciate in value), year after year after year. Consider that if I held the investment for 10 years and it simply held its value, that would be $750. Most people have no idea that they are still paying for that initial purchase many years later.  And, as noted, this is in addition to ongoing management fees paid for the fund adviser's expertise.

If this is surprising to you, you are not alone. As Schapiro highlights,

'I think that, despite paying billions of dollars, many investors do not understand what 12b-1 fees are. It's likely that some don't even know that these fees are being deducted from their funds or who they are ultimately compensating. In addition, investors may not realize they are paying the equivalent of sales loads or commissions—at a rate of ¾ of 1 percent a year—over the lifetime of their investment. Nor do investors realize that 10, 15, 20 or more years down the road, they may still be compensating the sales person who sold the fund.'

What we don't know can hurt us. As New York Times writer, Jeff Sommer, so elegantly describes:

'[o]ver a lifetime, expenses can have a devastating effect. Just 1 percent annually will eat away more than 40 percent of your nest egg over 60 years. That steady drain might well sink you.'

Full post as published by The Race to the Bottom on August 18, 2010 (boomark / email).