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How To Select A Financial Advisor: The Least You Should Know (Part 9 In eBook Series)



How To Select A Financial Advisor: The Least You Should Know (Part 9 In eBook Series)

Chapter 8: Hidden Ongoing Commissions

When I was growing up, I spent summers working on the family farm, which grew cotton, soybeans and rice. There were many snakes in the rice fields. I learned quickly that the snake you can see is not the one that bites you. It is the same way with hidden commissions, also known as 12(b)-1 fees. If you own a mutual fund or variable annuity, you are most likely paying a 12(b)-1 fee, whether you realize it or not. A 12(b)-1 fee is an ongoing commission often amounting to 1.0 percent of the value of your investment annually.

Named after the 1980 legislation that created them, 12(b)-1 fees were intended as one-year relief for struggling mutual funds. Today, over 70 percent of mutual funds and many variable annuities charge these onerous fees, which cost investors well over $10 billion each year. They are collected by the mutual fund directly from fund assets, and paid to the brokerage firm that holds the fund. Also known as trailing commissions or “trails,” these fees can be charged for many years for mutual funds, variable annuities, or other products that impose them.


Most mutual funds charge 12(b)-1 fees, including funds found in retirement plan investment menus, but the information is well-hidden. Unless you dig through the investment prospectus, you will not know how much you are losing to these fees each year. The fees are not identified on invoices. You can only find them by carefully looking at all the costs the mutual fund is applying to your investments.

Unlike advisory fees, which can be negotiated lower, 12(b)-1 fees are set by the mutual fund, and that is what you will pay if you own that fund.

Some mutual funds are referred to as “no-loads.” The implication is that they do not have sales charges. But no-load often just means that the fund does not charge a front-end load. These funds most certainly impose sales loads in the form of 12(b)-1 fees. Often, the 12(b)-1 fees are higher for so-called no-load funds in order to make up for the lack of a commission on the front end. A true no-load fund should not charge a 12(b)-1 fee.

To get a true understanding of the ongoing commissions you are paying for your investments, request that your advisor provide a written statement itemizing all the 12(b)-1 fees that your account(s) have generated over the past 12 months.

Although 12(b)-1 fees have been the subject of scrutiny by the Securities and Exchange Commission (SEC), little has been done so far to improve the situation for investors. In 2011, additional disclosures about these fees were mandated, but it’s unlikely that most investors will know where to find the information, nor understand its impact.

In 1998, I obtained a no-action letter from the National Association of Securities Dealers (NASD)—currently the Financial Industry Regulatory Authority (FINRA), the self-regulatory organization (SRO) for the securities industry. Specifically, I asked whether rebating 12(b)-1 fees to individuals by a broker dealer would be allowed (at this point in time, 12(b)-1 fees had never been rebated to an individual investor). The NASD reply indicated that it would take “no action” to prohibit this activity. Later, I obtained a similar no-action letter from the SEC. My intent was to provide individual investors the opportunity to recover some of the 12(b)-1 fees they were paying, since 12(b)-1 fees are not negotiable. Shortly after this “no-action letter” became available to the public, E*Trade started rebating 12(b)-1 fees. I do not know whether this opportunity still exists, or if my letter influenced them in any way.

12(b)-1 fees can be rebated, but as a practical matter, your broker will not rebate them because they are such a lucrative source of recurring revenue.

12(b)-1 fees destroy wealth silently. Each year, investors pay over $10 billion in 12(b)-1 fees, whether they realize it or not.
When mutual funds, annuities, or other investments charge high fees or commissions, their promoters may claim that they are delivering superior investment performance in exchange for those fees. In the next section of the book, I will discuss research that counters those arguments.

In 2019, the SEC announced a $125 million settlement with 79 firms that failed to disclose to clients they received 12(b) fees for recommending certain funds. The SEC found the firms promoted the high-fee share classes when less-expensive share classes were available in the same fund.

In an SEC initiative launched in 2018, the firms were allowed to self-report and avoid fines.

Have a question? Contact Ed Mahaffy.

Receive Complimentary Copy Of eBook (Includes All Graphic Charts)

Ed Mahaffy

Our first priority is helping you take care of yourself and your family. We want to learn more about your personal situation, identify your dreams and goals, and understand your tolerance for risk. Long-term relationships that encourage open and honest communication have been the cornerstone of my foundation of success.

Our approach is cost-effective and tax-efficient. As an independent investment advisor, we can offer you a personalized financial strategy, not a generic investment program. Your individual portfolio will be based on your unique situation, your values, your preferences and your goals. It will be designed to account for change, in the markets and in your circumstances.

As your professional partner, we’ll work hard to earn your trust and confidence, and provide the advice and service you deserve. Send me a note regarding any questions you may have about any particular investment concepts or products. We’ll get back to you quickly with a thoughtful answer.

Request A Copy of “How To Select A Financial Advisor” at

https://www.clientfirstwm.com/download-my-book

You can reach me directly at ed@clientfirstwm.com or call 501.603.0406

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