“Funds that pay 12-B fees” What does this mean? The fund pays fees to my broker that come out of me?
Yes, 12b1 fees are an annual fee fund companies pay to whichever brokerage handles your money. Usually they can run between 0.1-0.25%.
I avoid them for my clients by choosing index ETFs, most of which do not have such.
Not quite, Mr. Chance. The Department of Labor’s fiduciary rule applies to ERISA plans and IRA accounts, not all accounts. Mr. Finn was asking about non-retirement accounts.
http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=28806 (pdf).
You do say the rule applies to all the retirement plans you manage, which is true for U.S. plans.
This is exactly the type of advice that earns a good financial adviser his or her fee. Not everyone needs the hand holding but for those who do, the money paid may be worth it. I don’t need the guidance but I’m glad it’s available for people who do.
If you are a registered representative of a broker-dealer, the standard before the DOL fiduciary rule was the “suitability” standard. Technically, it still applies. The SEC and FINRA have not changed their rules on suitability but most people agree that the DOL’s fiduciary rule will prohibit some recommendations that are perfectly permissible under the suitability standard, but there aren’t really any recommendations that will unsuitable but consistent with the fiduciary duty. As a result, if you comply with the DOL’s fiduciary rule, you should not have to worry about suitability.
This is a reference to Advisers Act Rule 12b-1. In short, the rule allows a mutual fund to use its investors’ money to pay broker-dealers for helping to “distribute” (sell) the mutual fund shares. This fee is generally between 0.25% and 1% per year. It is separate from and in addition to a mutual fund’s management fee. In my opinion, it’s just another expense that helps brokers make money but it is of no benefit to investors. Last I knew, no Vanguard funds charged 12b-1 fees. Some Fidelity funds do, so watch carefully.
I could have sworn that was what I said. It goes this way, folks, because the Department of Labor has regulatory authority over only retirement accounts. Non-qualified money - which is non-retirement money in industry-speak - is not governed under the new rules. At my firm annuities are allowed under non-qualified accounts but not under qualified accounts. Another investment that’s off our approved list with the new regulatory system is Unit Investment Trusts.
I blush. But, as I said before, people could do their own taxes or change their own oil. I help those who don’t want to do that, whether it’s discipline, fear, time or whatever.
I am absolutely not kidding about that RV thing. Clients, never had any real money. He’s retired from the service and doing maintenance, she’s a SAHM (with no kids). Inherited $1.3MM. It’s been a steady holding action of ‘you want to retire? You can’t spend all of this? $7000 for a massage chair? No. $75K for an RV? Why?’ and helping them get set up in a new life. Busy time.
You say suitability, my firm says ‘best interest’. There is a carve-out under the new rules for a ‘best interest’ exemption in which the client signs away the fiduciary responsibility. I’ve never done one, but it’s there and allows for the client to go forward as if the old rules were still in place.
In my career, I have never seen a 12b-1 fee above 0.25%. I’d be astonished if there were many - though I’m sure there must be some. Looking it up that’s the maximum allowed. I wouldn’t put my clients into anything with that high a 12b-1, though.
How common are these fees among transactions? I hope I’m not being naive but say when you go in and start your account are you signing off on these fees?
Yes, you’ll agree to everything when you sign. I don’t see a way around it.
They’re not transaction-based, 12b-1 fees are product-based. So when you buy a mutual fund it’ll be included in the prospectus.
To avoid them, you can take the riskier route of buying individual stocks or just buy ETFs. Check the ETF literature carefully, however, some behave like mutual funds and may include a 12b-1.
Correction to my cite above – I meant to refer to Investment Company Act Rule 12b-1. (There is no Advisers Act Rule 12b-1.)
On the first point, it is what you said, and it was correct, but it was inappposite to Dewey Finn’s question. He was asking about non-retirement account recommendations by a broker representative. Your answer seemingly applied to retirement accounts or to accounts advised by someone other than a broker-dealer representative.
I’m not sure what your firm is describing as “best interest.” Generally people refer to fiduciary duties as requiring a person to act in the best interests of their clients. Broker-dealers are not subject to a fiduciary standard in all of their transactions. There is a lot of ongoing discussion of whether they should be.
Perhaps you are subject to a fiduciary standard in all your securities business because you are also an investment adviser representative and are acting in that capacity with your clients. If so, you would owe your clients fiduciary duties and would be expected to act in their “best interests.” Alternatively, if you advise only on 401(k) plans and IRA accounts, the DOL fiduciary rule would apply. It’s also possible, though unlikely, that your firm essentially imposed this best interest standard on itself. If your firm tells its clients it will act in their best interests, it must do so, even if it would not otherwise be required.
A simplified outline of the varying conduct standards that apply to various financial market professionals looks something like this:
(1) registered representatives of broker-dealers: suitability, under FINRA rules and SEC anti-fraud rules.
(2) representatives of federally-registered investment advisers: fiduciary duties under the federal securities laws, as interpreted by the SEC.
(3) essentially anyone making recommendations about retirement plans (e.g., 401(k) plans and IRA accounts): fiduciary duties, as interpreted by the Department of Labor.
(4) representatives of state-registered investment advisers: duties imposed by state law, which will generally be fiduciary duties as interpreted by the states.
(5) insurance salesmen: duties imposed by state law, which I hate to say, are generally something like “buyer beware.”
(6) bank representatives: It’s really complicated because they may be acting as:
(a) broker-dealer representatives: see (1) above (They should make it obvious when they are acting a broker-dealer representatives by using a different card and taking other steps. Customers don’t actually understand the distinction but the bank and the regulators do, so that’s good enough in the regulators’ opinions.);
(b) investment adviser representatives: see (2) above;
(c) trustees: fiduciary duties as interpreted by banking regulators and state trust law;
(d) securities dealers relying on the dealer registration exemption for banks: ? (I’m not sure, but federal anti-fraud provisions apply, which leads me to believe that the SEC’s suitability standard should apply, and there may be additional bank regulations that apply. FINRA rules won’t apply. I could some research if anyone really cares.)
(e) securities brokers relying on the broker exemption for banks: See (6)(d) immediately above;
(f) regular bank representatives doing things like opening bank accounts and not the things above: bank regulations.
Sometimes, more than one standard may apply. As I noted, a broker-dealer representative advising on an IRA account is subject to both the suitability rule and the DOL’s fiduciary standard. The same is true of an insurance agent selling variable annuities, which are subject to both state insurance laws and federal securities laws.
Different standards might also apply to the same person who has more than one role in the financial industry. These people are sometimes referred to as “dual-hatted” because they can change roles (and the duties they owe to customers) just by changing who they tell you they work for or what they do (“changing hats”). It’s like a superpower. A common example is a person who is a registered representative of a broker-dealer who is also an insurance salesman. Depending on which metaphorical hat the person is wearing when you do business with him or her, the responsibilities he or she owes you could be very different.
If a mutual fund charges 12b-1 fees, all the shareholders in that fund pay the fee. It is disclosed in the mutual fund’s prospectus. The way you pay the fee is that your performance in the fund is continuously reduced by the amount of the 12b-1 fee. It’s not a fee assessed at the time of the transaction and it does not show up as any sort of itemized fee disclosure just about your investment.
A mutual fund’s expense ratio includes its management fee and its 12b-1 fee (if any). It doesn’t matter how frequent 12b-1 fees are, you can avoid them by reading your disclosure documents and not buying funds that have unacceptably high expense ratios.
You can avoid 12b-1 fees even buying mutual funds. There are plenty of funds that don’t charge 12b-1 fees. Reading the prospectus is the best advice.
I’m also not aware of any ETFs that charge 12b-1 fees. For quirky reasons I don’t want to go into, many ETFs have authorized 12b-1 fees so their prospectuses discuss potential 12b-1 fees but I understand that these ETFs are not actually charging 12b-1 fees or paying them to broker-dealers. The reasons for this weird state of affairs are hard to explain. Jonathan Chance, if there are actually ETFs that are charging 12b-1 fees, I would sincerely appreciate your pointing one or two examples out to me. Thanks.
Disclosure documents of a particular fund, or for the whole firm you are at?
If it’s the fund, I’m getting that in deciding whether to invest one should look for 12b-1 activity, but also to check the expense ratio. Anything else to take into account?
To learn about 12b-1 fees and management fees, you want to review the disclosure documents, i.e., the prospectus, for each of the mutual funds you invest in.
There is a lot to understand and consider when picking your own investments. Factors to consider include:
- Your Time horizon (When do you plan to take the money?)
- Risk (How much of a decline in the value of the assets can you take, and is it worth taking that much risk in the hopes of achieving extra gains?)
*Cash flow (You inherited an IRA. I believe you will need, at a minimum, to make substantially equal periodic payments from the account, so you will probably want a fund that generates some income to help make these payments.) - Diversification (Which asset classes should you invest in? Generally, combining multiple asset classes, such as U.S. stocks, foreign stocks, government bonds, high-yield bonds, real estate, and commodities in the appropriate proportions can help you to reduce your risk, or to achieve better expected returns for the same amount of risk.)
- Management strategy (Index funds or actively-managed? Value or growth stocks? market timing? Leverage? I use index funds and I don’t use leverage. Your ability to use leverage in an IRA is limited.)
The truth is, I’m sure there are some great guides to investing that will help you if you want to do this on your own or to help you understand your adviser’s recommendations if you choose to use one.
Many years ago, the first I read was “The Only Investment Guide You’ll Ever Need,” and I’ve read many more advanced books in the years since. I don’t know how current that book is or whether better guides have come out since. Good luck.
SMBC today: long term saving.
This weekend, Freakonomics Radio had a very good broadcast that is germane to this thread. Very much worth a listen. (Link is to transcript and to a podcast link)
Thanks. Sounds very interesting.
OMG. Jack Bogle and The Mooch on one podcast? Amazeballs.
and The Mooch presented a better case for index funds!
Thanks for the great link to the Freakonomics podcast, jasg.
I have a link to a post on Seeking Alpha which may be of interest; Dalbar 2017: Investors Suck At Investing & Tips For Advisors
In addition to that, and as was mentioned in the podcast, managed funds often close. If this happens deep into a bear market and you’re not aware of it (because checking your investments makes you physically sick), you could miss the chance to reinvest the proceeds and ride the early stages of the next bull.
A last couple of points: I’m not aware of the tax implications but I don’t recall anyone mentioning how fast to buy the new funds. Do you put it all in at once or dollar-cost average? And are the dividends automatically reinvested (which is what I do) or do you collect them to make small side bets on individual stocks?
Everyone has their own level of risk aversion, so what might be the best choices for return may not be the best choices for you. If I were to come into a six-figure windfall I’d be worried I’d take more risks with it, so would try to do the opposite and be more cautious; stick it in a low-cost index tracker/s and forget about it.
I had a six-figure amount from a 401(k) I wanted to roll over into an existing Rollover IRA. I chose to move about 1/12 each month in. But this was during a rising market, and I might have been better off moving it all at once.