12b-1 Fees: Who Cares When You Have ETFs?

July 30, 2010

I don’t really disagree with your outrage regarding 12b-1 fees, Matt, but I think you missed a bigger point.

[CORRECTION: A previous version of this blog said that ETFs never charge 12b-1 fees. That was incorrect.

The author intended to point out that 12b-1 fees are the exception in the ETF industry and not the rule. But as a reader rightly pointed out, some ETFs do have 12b-1 fees, notably the Select Sector line of products from SSgA.

We apologize for the error.]

 

I hope the California sun hasn’t addled your brain already, but I’m worried. Your argument in “SEC Punts On 12b-1 Fees,” for all its factual fireworks, failed to remind readers that those 12b-1 fees (designed to help mutual fund companies pay for marketing costs) don’t matter if you use ETFs to get your investment exposure. ETFs don’t, for the most part, charge 12b-1 fees.

So, to the extent that I share your impatience and indignation about how investors are being bilked, let’s remember that you can largely avoid that nonsense by using ETFs. They’re also cheaper than mutual funds, as we explain in our IndexUniverse.com ETF Education Center. Specifically, in the article there titled “Why Are ETFs So Cheap?, readers can learn that while the average U.S. equity mutual fund charges 1.42 percent in annual expenses, the average equity ETF charges just 0.53 percent.

Moreover, if you look at where the bulk of ETF money is actually invested, the average fee is an even lower 0.40 percent. In other words, investors tend to gravitate to the lowest-cost funds, such as the S&P 500 SPDR (NYSEArca: SPY), which charges just 0.09 percent in annual fees.

Why bother even talking about 12b-1 fees as we’re doing now and in our article “SEC To Make Changes T 12b-1 Fees” when you can own the biggest U.S. companies for a fraction of the price of any mutual fund?

Throw Mary A Bone

I also thought you were a little bit unhinged in terms of failing to acknowledge what the political reality must be for a regulator like Mary Schapiro at the Securities and Exchange Commission. Imagine grappling day in and day out with a multitude of competing interests.

You and I both know that no one in Washington, D.C., can quickly undo the way 12b-1 fees have been corrupted over the years. Helping mutual funds defray marketing costs by charging shareholders extra may have made sense long ago, but no more. I agree with you there. But we can’t expect the SEC, by fiat, to do away with 12b-1 fees with the wave of a wand. Things don’t work that way.

Politics is a slow, plodding and sometimes ugly business. I think it was Otto von Bismarck, the 19th-century German statesman, who said something to the effect that politics is like sausage making: The closer you get to it, the less you want to know.

Still, I applaud the SEC for staying on the case, and you ought to as well. It’s doing what it can.

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