How Bad is the Retirement Crisis?
Bad and getting worse, according to a recent column by David Ignatius who paints a bleak picture about the prospects for people approaching retirement.
Among His Key Points:
--Only about 50% of Americans have an employer-sponsored retirement plan, the rest will rely on Social Security for retirement income;
--A typical boomer worker would receive a monthly benefit of about $2,400 at a retirement age of 66 in 2020;
--Not surprisingly, a National Bureau of Economic Research (NBER) study found that people are not good at doing their own financial planning, which is the key element of creating a viable 401(k) plan. The 401(k) replaced pension plans because they were cheaper and had less legal (fiduciary) responsibility burdens for corporations. The mutual fund industry loves 401(k)s since people cannot tell good funds from bad ones, and expensive ones from cheaper ones. That gets into the entire discussion of 12b-1 fees which all 401(k) participants better become familiar with. (See numerous other posts on the important of 12b-1 fees on this blog.)
--Another study noted by Mr. Ignatius is one from the Congressional Research Service. which found that 53% of households hold at least one retirement account, but unfortunately, the median combined balance was only $45,000.
--But perhaps the worst news was this: The NBER found that, as of 2004, the typical boomer household was holding nearly 50% of its wealth in housing equity. That's the kicker: the decline in financial assets combined with the decline in housing equity has devastated retirement plans for millions of people. And this problem will not be solved soon.
More details about the link between housing wealth and retirement, including the all-important amount of time it will take to recover these hard-dollar losses can be found in my white paper on housing, plus other posts on this blog.
What we now have is a major problem which finds the children of the Greatest Generation becoming the Lost Generation, in terms of their financial well-being.
The current economic crisis has wiped out half a generation of wealth. The investment boom days will not be coming soon, or at all. This accounts for the new frugality stories we are seeing in the major media.
Reasons for This Problem:
After writing about retirement and investing since the mid-1970s, you could say this has been a crisis in the making for about 25 years. The first problem was the decline in pension funds offered by corporations.
Mr. Ignatius notes that about 80% of employees in medium and large companies had pension plans in 1985, according to the U.S. Labor Department. By 2000, defined-benefit recipients fell to just 36%. The decline in pension plans is directly related to the break in the relationships between employers and employees, accompanied by the decline in union memberships. When unions got weaker, pension plans declined.
Among the other problems:
--pension plans because too expensive to run;
--They often could not often meet their actuarial projections;
--They were being looted by corporate raiders, investment managers, consultants and/or their parent corporation.
401(k)s: The Great Experiment
I had a proposed book title about the rise of 401(k)s called "The Great Experiment," but could not find an agent. The idea behind this book was that 401(k)s serve a purpose, but most people would prefer a pension, or some type of annuitized income product (not necessarily an annuity which carries too many hidden fees.)
This annuitized product could be offered by a fraternal organization, church or professional society for its members and span an entire lifetime. It would provide a floor-level income, and possibly housing, but security and peace of mind are worth millions to a participant, but are outside the purview of the financial services providers who focus on flooding the market with redundant mutual funds which often carry fees that are too high versus the level of service and investment returns they deliver.
--Chuck Epstein
cepstein@prodigy.net
Thursday, May 7, 2009
Monday, May 4, 2009
Fund Expenses Expected to Increase in 2009
A timely column by Marketwatch reporter Chuck Jaffe reiterates the importance of watching expenses and provides a sad prediction that mutual funds will be raising their expenses in 2009 despite the decline in market performance and the negative effect this will have on shareholders.
This is more bad news for mutual fund investors.
Aside from the decline in other financial assets, including house prices, every penny paid in higher fee es will add to the recovery time a person's sick financial balance sheet.
But mutual fund companies control their fee structures without any input from their customers. That's part of the "heads I win, tails you lose" game, which is too common in the financial services industry.
Mr. Jaffe does a good job of presenting the latest news. Now, it is up to shareholders to bite the bullet, and accept the higher fees, or else move into any other similar fund or ETF which can provide the same asset class or strategy coverage at a lower cost.
If you find one, make the move. There should not be anything such as customer loyalty in the mutual fund business which is based solely on total net performance.
As discussed in other posts, most mutual funds are commodities. The simple reality is there are are too many similar funds following the same strategies, asset classes, research and charts.
While manager personalities may play a role in the marketing, the reality is that top-tier funds do not stay there long. They rotate on a pretty consistent basis. "Every dog has its day" is a great slogan for portfolio managers and a star today can be a dog tomorrow. Even Morningstar's rating system plays a role in this ongoing charade since 10% of Morningstar's funds in any category have to be rated five-star funds. In education, that is known as grade inflation.
In the world of mutual fund marketing, that is a great gimmick to help sell funds, fund research, and the rights to use Morningstar's rating system in fund advertising.
All this is more reason why shareholders should start monitoring fund expenses, shelf space deals and advisor paid fees. The caveat is that fund companies do not want you to readily discover this information. You have to do a "Where's Waldo" routine using the fund prospectus to distill the key sentences from an already hard-to-read brochure.
By remember, fees are serious. While we may be talking about pennies and basis points, every penny in fund expenses cuts into your personal net return.
Also, watch this space about the looming battle about 12b-1 fees at the SEC. SEC Chairwoman Mary Schapiro said it should take place in the second half of 2009. This is a discussion which involves billions of dollars in money charged to shareholders. It will be a great example of the mutual fund industry versus shareholders.
This is more bad news for mutual fund investors.
Aside from the decline in other financial assets, including house prices, every penny paid in higher fee es will add to the recovery time a person's sick financial balance sheet.
But mutual fund companies control their fee structures without any input from their customers. That's part of the "heads I win, tails you lose" game, which is too common in the financial services industry.
Mr. Jaffe does a good job of presenting the latest news. Now, it is up to shareholders to bite the bullet, and accept the higher fees, or else move into any other similar fund or ETF which can provide the same asset class or strategy coverage at a lower cost.
If you find one, make the move. There should not be anything such as customer loyalty in the mutual fund business which is based solely on total net performance.
As discussed in other posts, most mutual funds are commodities. The simple reality is there are are too many similar funds following the same strategies, asset classes, research and charts.
While manager personalities may play a role in the marketing, the reality is that top-tier funds do not stay there long. They rotate on a pretty consistent basis. "Every dog has its day" is a great slogan for portfolio managers and a star today can be a dog tomorrow. Even Morningstar's rating system plays a role in this ongoing charade since 10% of Morningstar's funds in any category have to be rated five-star funds. In education, that is known as grade inflation.
In the world of mutual fund marketing, that is a great gimmick to help sell funds, fund research, and the rights to use Morningstar's rating system in fund advertising.
All this is more reason why shareholders should start monitoring fund expenses, shelf space deals and advisor paid fees. The caveat is that fund companies do not want you to readily discover this information. You have to do a "Where's Waldo" routine using the fund prospectus to distill the key sentences from an already hard-to-read brochure.
By remember, fees are serious. While we may be talking about pennies and basis points, every penny in fund expenses cuts into your personal net return.
Also, watch this space about the looming battle about 12b-1 fees at the SEC. SEC Chairwoman Mary Schapiro said it should take place in the second half of 2009. This is a discussion which involves billions of dollars in money charged to shareholders. It will be a great example of the mutual fund industry versus shareholders.
Sunday, May 3, 2009
Why Mutual Fund Expenses Matter to Shareholders
By Chuck Epstein
There are over 8,000 mutual funds in the U.S.* and virtually all of them charge fees to shareholders to help offset their operating expenses. This is a normal cost of doing business.
But the mutual fund industry considers itself special. Over the years, it has lobbied securities regulators for exceptional treatment, especially in the area of offsetting their large mutual fund marketing and sales expenses by charging these costs off to shareholders. The vehicle for this relief comes in the form of fees which fall under the esoteric name of SEC Rule 12b-1, which governs the fees paid to mutual fund dealers as compensation for selling a fund company’s products.
These fees were introduced as part of the Securities and Exchange Commission (SEC) 1940 Act. According to a paper from SEC financial economist Lori Walsh, “the original justification for the plans, as put forth by the mutual fund industry in the 1970s, was that such (12b-1) fees help attract new shareholders into funds through advertising and by providing incentives for brokers to market the fund.”
The corollary is that as the number of shareholders increased, it would reduce fund expenses by passing along any scale of economy which was generated from providing many of the same services to a larger body of shareholders. But that was largely theory.
In practice, there are many instances when 12b-1 fees pit shareholder interests against those of load fund companies. SEC economist Walsh’s study found that “while funds with 12b-1 plans do, in fact, grow faster than funds without them, shareholders are not obtaining benefits in the form of lower average expenses or lower flow volatility. Fund shareholders are paying the costs to grow the fund, while the fund adviser is the primary beneficiary of the fund’s growth.”
This is the inherent conflict of interest which places load mutual fund companies on a collision course with their own shareholders. Today, the way 12b-1 fees are being used raises serious questions about the fiduciary role of load mutual fund companies and their sales intermediaries.
In the case of too many fund companies, the misuse of 12b-1 and other poorly disclosed fee arrangements, such as shelf space deals and revenue sharing agreements, are legal, yet they have created serious ethical problems. These conflicts should justifiably raise the issue of whether shareholders can trust the hidden motives and judgment of the financial rep who sold them the mutual fund in the first place, as well as the fund company itself which pays for these practices.
12b-1: A Very Controversial Fee
These fees have always been controversial and debated at the highest levels of the mutual fund industry. The reason: they determine how billions of dollars of shareholder money is spent at load mutual fund companies on fund administration, sales/marketing expenses, salaries for portfolio managers, and something which is not publicly discussed, how millions in ancillary expenses are wasted on sales junkets, national wholesaler networks, excessive salaries, and trinkets for financial reps which range from golf balls, barbeque sets, wine, paperweights, key chains, clothing, umbrellas, to dinners, wine tastings, and “value-added events.”
The 12b-1 fee also points out the wide gap in fiduciary responsibility which exists under ERISA plans and the fiduciary role, however, weak, which exists between a financial representative and their investor client. Under ERISA, for example, a pension plan trustee or executive who diverted plan participant money to pay for personal expenses, triggered a serious set of repercussions, which could go as high as the U.S. Department of Labor or Justice Department.
I saw this first-hand during the mid-1970s when I worked at the notorious Teamster’s Central States Pension Fund in Chicago which, at the time, was under DOL trusteeship. At the time, the Central States Fund was the largest Taft-Hartley pension fund in the U.S. with $1.5 billion in assets (How times have changed.)
In one instance at the Teamsters Fund, some trustees were attending a board meeting in California and went to the pro golf shop where they bought golf supplies and charged it to their rooms. The room expenses were reimbursed with pension fund assets, which triggered an ERISA violation: diverting pension plan assets for personal use. The DOL then made sure the Fund was reimbursed and the trustees reprimanded.
Yet when I was working for a mutual fund company, a conference event planner said she reluctantly had to sign an expense account for a mutual fund wholesaler who bought $2,000 worth of wine and had it delivered to his room for personal use. This exact same violation would be impermissible and punished under ERISA standards, yet it went unpunished by the mutual fund company.
The wine was paid for using 12b-1 fees. Shareholders did not get a chance to sample this wine, they just paid the bill. This double standard between ERISA fiduciary standards versus laissez faire load mutual fund company spending raises the critical question: Who is the advocate for the mutual fund company shareholders? Even worse, what happens when 12b-1 fees are used against shareholders, whether they are in the form of keeping fund expense ratios high as fund assets grow or the blatant abuse of fund spending on frivolous items?
The Role of 12b-1 Fees and Wholesalers
In an SEC-sponsored public roundtable on 12b-1 fees held in June 2007, panelists discussed the history, role of these fees in fund distribution, costs and benefits, and options for reforming this set of fees. An interesting memo issued by the law firm of Willkie Far and Gallagher summarizes this discussion.
The memo correctly notes that 12b-1 fees are charged to some degree by fund companies, including no-load funds, as a means of compensating intermediaries for selling their funds, shareholder communications and other administrative costs. If a fund charges a small 12b-1 fee and works to keep expenses low, it can call itself a no-load fund. This category of fund company usually adopts the direct sales model in which investors buy directly from the company
In contrast, load fund companies often sell their funds using a national sales force of wholesalers, supported by internal sales support staff, and a marketing department which produces materials for both shareholder and broker-dealer use.
From my experience, the load-fund sales model has an entirely different focus versus the direct sales (no-load) model. At load funds, the most important audience is the company’s own national wholesaler sales force, followed by the financial intermediaries (brokers and financial reps) which directly interface with shareholders.
Despite much of the load fund industry rhetoric, the least important audience is individual shareholders. I estimate these two groups (wholesalers and financial intermediaries) receive about 90% of the marketing department’s attention, while individual shareholders receive 10%. (From a budget perspective, these proportions differ since a national wholesaler and internal sales support staff could number around 250 people, while there may be hundreds of thousands of individual shareholders.)
And what do wholesalers do? In the words of an industry publication, “wholesalers spend their lives attending conferences for financial advisers, taking advisers out to swank restaurants, criss-crossing the country to give presentations to advisory firms or to help an adviser give a seminar on investing to prospects.” The problem is that the majority of these presentations are fund specific. The vast majority of wholesalers are not CFAs and most will not or cannot discuss other strategies and products, such as ETFs or no-load funds, which often are better suited to client needs.
Yet despite the narrow focus of mutual fund wholesalers, they are exceptionally well compensated. According to a January 2006 report from the mutual fund research firm, Kasina, total external wholesaler compensation can range from $225,000 for an average-performing wholesaler to over $500,000 annually for top performers.
A salary comparison from the firm Saleslogix found that mutual fund wholesalers are among the most highly paid professionals in the nation, ranking as high as doctors and lawyers. However, even this salary figure understates the remuneration since 100% of any mutual fund wholesalers’ expenses are reimbursable by their mutual fund company employer. This includes all meals, gasoline, travel, office, auto, and telecommunications expenses.
One fund wholesaler was so inconvenienced from putting in his car expense reports that he leased one and had the fund company pick up the entire tab instead. Plus, unlike doctors and lawyers, mutual fund wholesalers do not pay for expensive malpractice or professional indemnity insurance. The money to pay for these salaries and expenses comes from 12b-1 fees which, you guessed it, all comes from the shareholders.
What’s Ahead?
At the time of the SEC conference on 12b-1 fees held in June 2007, then-Chairman Christopher Cox said the Commission would act on 12b-1 rules later in 2007. Nothing significant happened. At a conference in April 2009, I asked SEC Chairwomen Mary Shapiro about 12b-1 fees and she again repeated that they were high on the SEC’s agenda and some action would be taken in the second half of 2009. This will be a high-level debate, but if the past serves as any example, individual shareholders’ interests will not be represented.
This is because Wall Street reform is inherently evolutionary. Given the powerful lobbying from the Investment Company Institute, the Profit-Sharing Council of America and various law firms representing individual load fund company clients, this debate could easily result in actions which will reduce shareholder returns in direct proportion to a load fund company’s high expense ratios. In practice, this means that it will take shareholders years longer to recoup their market losses since they will have to first pay for the expenses of their load fund company before they see any return posted to their personal fund accounts.
To ad insult to injury, after the shareholder pay the 12b-1 fees and the wholesalers bring in new investors regardless of the costs, the fund company often does not pass along any scale of economy they achieved from adding more shareholders to their existing service model. This was a main reason for charging the fees in the first place, yet these scales of economy are often never passed along to reduce overall fund expenses.
Since the 12b-1 issue is so esoteric and involves billions of dollars, many shareholders will not even be aware it is happening. This will be a costly mistake since the current economic imbroglio, which combines the decline in housing wealth and portfolio assets, has effectively wiped out a generation of wealth.
Reducing 12b-1 expenses will benefit shareholder by allowing fund returns to post slightly greater gains at a faster rate as fund expense ratios are reduced. If this occurs, fund companies would have to re-shape their business practices to become more competitive and less commoditized. But maybe that is exactly what they are trying to avoid in the first place.
*Investment Company Institute, 2007 Fact Book.
May 1, 2009
There are over 8,000 mutual funds in the U.S.* and virtually all of them charge fees to shareholders to help offset their operating expenses. This is a normal cost of doing business.
But the mutual fund industry considers itself special. Over the years, it has lobbied securities regulators for exceptional treatment, especially in the area of offsetting their large mutual fund marketing and sales expenses by charging these costs off to shareholders. The vehicle for this relief comes in the form of fees which fall under the esoteric name of SEC Rule 12b-1, which governs the fees paid to mutual fund dealers as compensation for selling a fund company’s products.
These fees were introduced as part of the Securities and Exchange Commission (SEC) 1940 Act. According to a paper from SEC financial economist Lori Walsh, “the original justification for the plans, as put forth by the mutual fund industry in the 1970s, was that such (12b-1) fees help attract new shareholders into funds through advertising and by providing incentives for brokers to market the fund.”
The corollary is that as the number of shareholders increased, it would reduce fund expenses by passing along any scale of economy which was generated from providing many of the same services to a larger body of shareholders. But that was largely theory.
In practice, there are many instances when 12b-1 fees pit shareholder interests against those of load fund companies. SEC economist Walsh’s study found that “while funds with 12b-1 plans do, in fact, grow faster than funds without them, shareholders are not obtaining benefits in the form of lower average expenses or lower flow volatility. Fund shareholders are paying the costs to grow the fund, while the fund adviser is the primary beneficiary of the fund’s growth.”
This is the inherent conflict of interest which places load mutual fund companies on a collision course with their own shareholders. Today, the way 12b-1 fees are being used raises serious questions about the fiduciary role of load mutual fund companies and their sales intermediaries.
In the case of too many fund companies, the misuse of 12b-1 and other poorly disclosed fee arrangements, such as shelf space deals and revenue sharing agreements, are legal, yet they have created serious ethical problems. These conflicts should justifiably raise the issue of whether shareholders can trust the hidden motives and judgment of the financial rep who sold them the mutual fund in the first place, as well as the fund company itself which pays for these practices.
12b-1: A Very Controversial Fee
These fees have always been controversial and debated at the highest levels of the mutual fund industry. The reason: they determine how billions of dollars of shareholder money is spent at load mutual fund companies on fund administration, sales/marketing expenses, salaries for portfolio managers, and something which is not publicly discussed, how millions in ancillary expenses are wasted on sales junkets, national wholesaler networks, excessive salaries, and trinkets for financial reps which range from golf balls, barbeque sets, wine, paperweights, key chains, clothing, umbrellas, to dinners, wine tastings, and “value-added events.”
The 12b-1 fee also points out the wide gap in fiduciary responsibility which exists under ERISA plans and the fiduciary role, however, weak, which exists between a financial representative and their investor client. Under ERISA, for example, a pension plan trustee or executive who diverted plan participant money to pay for personal expenses, triggered a serious set of repercussions, which could go as high as the U.S. Department of Labor or Justice Department.
I saw this first-hand during the mid-1970s when I worked at the notorious Teamster’s Central States Pension Fund in Chicago which, at the time, was under DOL trusteeship. At the time, the Central States Fund was the largest Taft-Hartley pension fund in the U.S. with $1.5 billion in assets (How times have changed.)
In one instance at the Teamsters Fund, some trustees were attending a board meeting in California and went to the pro golf shop where they bought golf supplies and charged it to their rooms. The room expenses were reimbursed with pension fund assets, which triggered an ERISA violation: diverting pension plan assets for personal use. The DOL then made sure the Fund was reimbursed and the trustees reprimanded.
Yet when I was working for a mutual fund company, a conference event planner said she reluctantly had to sign an expense account for a mutual fund wholesaler who bought $2,000 worth of wine and had it delivered to his room for personal use. This exact same violation would be impermissible and punished under ERISA standards, yet it went unpunished by the mutual fund company.
The wine was paid for using 12b-1 fees. Shareholders did not get a chance to sample this wine, they just paid the bill. This double standard between ERISA fiduciary standards versus laissez faire load mutual fund company spending raises the critical question: Who is the advocate for the mutual fund company shareholders? Even worse, what happens when 12b-1 fees are used against shareholders, whether they are in the form of keeping fund expense ratios high as fund assets grow or the blatant abuse of fund spending on frivolous items?
The Role of 12b-1 Fees and Wholesalers
In an SEC-sponsored public roundtable on 12b-1 fees held in June 2007, panelists discussed the history, role of these fees in fund distribution, costs and benefits, and options for reforming this set of fees. An interesting memo issued by the law firm of Willkie Far and Gallagher summarizes this discussion.
The memo correctly notes that 12b-1 fees are charged to some degree by fund companies, including no-load funds, as a means of compensating intermediaries for selling their funds, shareholder communications and other administrative costs. If a fund charges a small 12b-1 fee and works to keep expenses low, it can call itself a no-load fund. This category of fund company usually adopts the direct sales model in which investors buy directly from the company
In contrast, load fund companies often sell their funds using a national sales force of wholesalers, supported by internal sales support staff, and a marketing department which produces materials for both shareholder and broker-dealer use.
From my experience, the load-fund sales model has an entirely different focus versus the direct sales (no-load) model. At load funds, the most important audience is the company’s own national wholesaler sales force, followed by the financial intermediaries (brokers and financial reps) which directly interface with shareholders.
Despite much of the load fund industry rhetoric, the least important audience is individual shareholders. I estimate these two groups (wholesalers and financial intermediaries) receive about 90% of the marketing department’s attention, while individual shareholders receive 10%. (From a budget perspective, these proportions differ since a national wholesaler and internal sales support staff could number around 250 people, while there may be hundreds of thousands of individual shareholders.)
And what do wholesalers do? In the words of an industry publication, “wholesalers spend their lives attending conferences for financial advisers, taking advisers out to swank restaurants, criss-crossing the country to give presentations to advisory firms or to help an adviser give a seminar on investing to prospects.” The problem is that the majority of these presentations are fund specific. The vast majority of wholesalers are not CFAs and most will not or cannot discuss other strategies and products, such as ETFs or no-load funds, which often are better suited to client needs.
Yet despite the narrow focus of mutual fund wholesalers, they are exceptionally well compensated. According to a January 2006 report from the mutual fund research firm, Kasina, total external wholesaler compensation can range from $225,000 for an average-performing wholesaler to over $500,000 annually for top performers.
A salary comparison from the firm Saleslogix found that mutual fund wholesalers are among the most highly paid professionals in the nation, ranking as high as doctors and lawyers. However, even this salary figure understates the remuneration since 100% of any mutual fund wholesalers’ expenses are reimbursable by their mutual fund company employer. This includes all meals, gasoline, travel, office, auto, and telecommunications expenses.
One fund wholesaler was so inconvenienced from putting in his car expense reports that he leased one and had the fund company pick up the entire tab instead. Plus, unlike doctors and lawyers, mutual fund wholesalers do not pay for expensive malpractice or professional indemnity insurance. The money to pay for these salaries and expenses comes from 12b-1 fees which, you guessed it, all comes from the shareholders.
What’s Ahead?
At the time of the SEC conference on 12b-1 fees held in June 2007, then-Chairman Christopher Cox said the Commission would act on 12b-1 rules later in 2007. Nothing significant happened. At a conference in April 2009, I asked SEC Chairwomen Mary Shapiro about 12b-1 fees and she again repeated that they were high on the SEC’s agenda and some action would be taken in the second half of 2009. This will be a high-level debate, but if the past serves as any example, individual shareholders’ interests will not be represented.
This is because Wall Street reform is inherently evolutionary. Given the powerful lobbying from the Investment Company Institute, the Profit-Sharing Council of America and various law firms representing individual load fund company clients, this debate could easily result in actions which will reduce shareholder returns in direct proportion to a load fund company’s high expense ratios. In practice, this means that it will take shareholders years longer to recoup their market losses since they will have to first pay for the expenses of their load fund company before they see any return posted to their personal fund accounts.
To ad insult to injury, after the shareholder pay the 12b-1 fees and the wholesalers bring in new investors regardless of the costs, the fund company often does not pass along any scale of economy they achieved from adding more shareholders to their existing service model. This was a main reason for charging the fees in the first place, yet these scales of economy are often never passed along to reduce overall fund expenses.
Since the 12b-1 issue is so esoteric and involves billions of dollars, many shareholders will not even be aware it is happening. This will be a costly mistake since the current economic imbroglio, which combines the decline in housing wealth and portfolio assets, has effectively wiped out a generation of wealth.
Reducing 12b-1 expenses will benefit shareholder by allowing fund returns to post slightly greater gains at a faster rate as fund expense ratios are reduced. If this occurs, fund companies would have to re-shape their business practices to become more competitive and less commoditized. But maybe that is exactly what they are trying to avoid in the first place.
*Investment Company Institute, 2007 Fact Book.
May 1, 2009
Saturday, May 2, 2009
How Mutual Fund Expenses Hurt Shareholders
When the average investor buys $10,000 of Class A shares in a load mutual fund, how much of their money actually gets invested in the market?
If you thought it would be $10,000, you are not even close.
The way load mutual funds typically operate, by the time the average investor puts down $10,000 and leaves the investment rep’s office, only $9,450 will be invested in the market. The other $550 gets eaten up by sales charges which go to the selling broker-dealer and the fund distributor. In addition, another $50 typically is paid as an underwriting commission to the fund distributor.
(For a graphic of this process, see chart for a schematic of how these fees are charged to shareholders. Note: this chart has some ovals which are hard to read, but the first oval (farthest left) for Class A shares, says “Account $9,450.” The second oval says” $50 underwriting commission.” The third oval says “$500.")
That’s just for starters. Every year, the shareholder pays about 25 basis points (bps), or one-quarter of 1% in 12b-1 fees, plus a management fee of about 90 bps, plus a $20 administrative fee to the fund distributor.
The fee structures for Class B and Class C shares are different based on deferred sales charges, and higher initial investments. The common denominator in terms of fees for all these share classes is the 12b-1 fee and the administrative fee.
The Important Point
The key thing for shareholders to remember is that the 12b-1 fees are charged annually to shareholders by the fund distributor to primary pay for the mutual fund company’s sales and marketing efforts. The original stated goal of 12b-1 fees which was presented to regulators was to increase shareholder communications and boost fund assets which, in turn would lower fund expenses. That was the idealized version. Today, most fund companies, especially load companies, charge the 12b-1 fees to subsidize sales and marketing efforts, yet they rarely lower shareholder expenses. The higher the fund company’s expense ratio, the lower the shareholder’s total investment return.
The bottom line: 12b-1 fees are good for fund companies, and bad for shareholders.
In future posts, we'll look at how hidden revenue sharing agreements, shelf-space deals and other expenses which are not readily disclosed to shareholders erode returns.
If you thought it would be $10,000, you are not even close.
The way load mutual funds typically operate, by the time the average investor puts down $10,000 and leaves the investment rep’s office, only $9,450 will be invested in the market. The other $550 gets eaten up by sales charges which go to the selling broker-dealer and the fund distributor. In addition, another $50 typically is paid as an underwriting commission to the fund distributor.
(For a graphic of this process, see chart for a schematic of how these fees are charged to shareholders. Note: this chart has some ovals which are hard to read, but the first oval (farthest left) for Class A shares, says “Account $9,450.” The second oval says” $50 underwriting commission.” The third oval says “$500.")
That’s just for starters. Every year, the shareholder pays about 25 basis points (bps), or one-quarter of 1% in 12b-1 fees, plus a management fee of about 90 bps, plus a $20 administrative fee to the fund distributor.
The fee structures for Class B and Class C shares are different based on deferred sales charges, and higher initial investments. The common denominator in terms of fees for all these share classes is the 12b-1 fee and the administrative fee.
The Important Point
The key thing for shareholders to remember is that the 12b-1 fees are charged annually to shareholders by the fund distributor to primary pay for the mutual fund company’s sales and marketing efforts. The original stated goal of 12b-1 fees which was presented to regulators was to increase shareholder communications and boost fund assets which, in turn would lower fund expenses. That was the idealized version. Today, most fund companies, especially load companies, charge the 12b-1 fees to subsidize sales and marketing efforts, yet they rarely lower shareholder expenses. The higher the fund company’s expense ratio, the lower the shareholder’s total investment return.
The bottom line: 12b-1 fees are good for fund companies, and bad for shareholders.
In future posts, we'll look at how hidden revenue sharing agreements, shelf-space deals and other expenses which are not readily disclosed to shareholders erode returns.
Subscribe to:
Posts (Atom)
