Watch out for the sneakiest fee.

12b-1 fees crop up even on no-load mutual funds 

After three straight years of knockout stock market gains, you probably haven't noticed the notorious 12b-1 fee at work. Yes, you may have caught on that fund fees now average 1.5% of your invested savings, and perhaps you've even grasped the difference between a front-end and back-end load down cold (see "Nothing Comes Free," Moneywise, May 1998). While those charges are pretty easy to spot and compare from fund to fund, the 12b-1 is a sneakier fee that might creep up on your mutual fund invest creep up on your mutual investment and catch you unawares.

It's also why the 12b-1 has caused its share of controversy. Named after a rule the Securities and Exchange Commission (SEC) passed to allow fund companies to use it, the 12b-1 is now charged by over half of all mutual funds. On the surface, it's meant to pay for a host of items, including marketing and advertising costs such as sending out pamphlets and prospectuses. Mutual funds used it as an incentive, a way to woo brokers and financial planners for pushing their investment over others that might not pay the fee. The 12b-1 fees also pay for so-called distribution-related expenses such as printing and mailing reports to shareholders.

The fact of the matter is, you could very well be stuck with a 12b-1 fee, yet not be aware of it. Funds that charge fees when you purchase or sell shares are easily distinguishable in the industry: they're listed as "load" funds. But don't be fooled into thinking that all no-load funds shun 12b-1 fees. Michelle Smith, managing director for the Mutual Fund

Education Alliance based in Kansas City, Missouri, notes that a fund can charge a 12b-1 fee of up to 0.25% and still call itself "no-load." Even though this is a relatively low fee, says Smith, the trick is to choose one with an even lower fee scale. However, some critics say 12b-1 fees are nothing more than a disguised "load" or sales fee.

Given that the stock market has logged three great years, and knowing that the average 12b-1 fee is 0.5% for stock funds and 0.35% for bond funds, according to Lipper Analytical Services Inc., your first tendency might be to write it all off. Don't. Annual 12b-1 fees can run as high as 1% of a fund's assets. According to Olivia Barbee, an analyst with Morningstar, the Chicago company that tracks the mutual fund industry, over a ten-year period with stocks gaining about 10% annually, forking over a puny 1% each year will shave a full $2,300 off every $10,000 you put into a mutual fund. What's more, 12b-1 fees have risen sharply in recent years. In 1995, the typical 12b-1 fee was 0.31% for equity funds and 0.26% for fixed-income funds.

When they were first introduced in the early 1980s, 12b-1 fees were touted as a boon to fundholders. The thinking was that by increasing the number of investors and thereby realizing economies of scale, 12b-1 fees would lower overall fund costs. They haven't, say industry experts. Numerous mutual funds continue to charge 12b-1 fees even after they've closed their doors to new investors or reached a size where they don't want to grow anymore. This has led to complaints from consumer advocates and even some within the industry, including John Bogle, founder of the Vanguard Group, that 12b-1 fees are excessive and unnecessary. The only way to know whether you're being hit with a 12b-1 fee is to check your fund prospectus. In addition to telling you the fund's objective, holdings and performance, the prospectus discloses all fees investors must pay. Another option is to look over Morningstar sheets, available in many libraries.

In the meantime, you might consider whether you want to invest at all in a mutual fund that has a 12b-1 fee. Research shows that the 12b-1 fee is "a deadweight cost borne by shareholders and has no tangible benefit to investors," says Robert McLeod, Ph.D., a finance professor at the University of Alabama's Culver House College of Commerce & Business Administration in Tuscaloosa, Alabama. "In general, 12b-1 funds have higher expense ratios and lower net investment returns than non-12b-1 funds."

If you've got a choice between funds, all other things being equal, you're probably better off selecting the one with the lower expenses.

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