Hidden fees!? In the corner of the exchange traded fund (ETF) world, some people are whispering about the clauses that a few fund providers put in their prospectus that would let the providers charge a 12b-1 fee. But wait…what is a 12b-1 fee?
12b-1 fees are a way for fund companies to pass on the costs of marketing, record-keeping and commissions to the investor, writes Scott Burns for Seeking Alpha. The fees are capped at 0.25%, and the investor could keep on paying the fee as long as the fund is held.
Only a very few ETFs charge 12b-1 fees – the cost advantages of ETFs is still one of their major characteristics. The average ETF expense ratio is 0.55% and the average expense for an open-end index fund is 0.81%. ETFs that do charge 12b-1 fees are still competitive because of their lower costs in other areas or because of the waiving of fees.
The real concern is over the possibility of future additional fees. Some ETF providers reserve the right to charge 12b-1 fees in the future. Still, if an ETF provider does decide to reallocate money from expenses to 12b-1, overall fees will likely stay the same.
Market efficiency will likely stamp out a fund provider’s ambitions to charge 12b-1 fees since any provider that would add the fee will probably find themselves with less liquidity as investors shop for other low-cost options. The universal forces of supply and demand will keep the costs down.
Furthermore, Securities and Exchange Commission chairman Mary Schapiro has already shown her dislike of the practice, and doing away with the 12b-1 rule, along with making major changes to disclose the source of fees, is on the top of the SEC’s to-do-list.
For more information on ETFs and taxes, visit our taxes category.
Max Chen contributed to this article.