Fee Structures and Other Costs

Knowing which bucket a fee belongs to matters for suitability: a client comparing "no-load" funds is not automatically comparing zero-fee funds, and a client comparing expense ratios is not comparing total cost of ownership if a load applies.

How Are Sales Charges (Loads) Structured?

• Front-end load: Deducted from purchase amount (Class A)
• Back-end load / Contingent Deferred Sales Charge (CDSC): Charged upon redemption (Class B, sometimes Class C)
• POP = NAV + Sales Charge (for front-end load funds)
• No-load: No sales charge, but may have 12b-1 fees up to 0.25%

What Do 12b-1 Fees Pay For?

Annual fee deducted from fund assets (reduces NAV over time). Two different rules govern it. The SEC's mutual-fund distribution-fee rule lets a fund pay these costs from its own assets under a written, board-approved plan, and sets no dollar limit.

The fund's actual spending is capped by a separate FINRA sales-charge rule, covering two distinct components:

• Distribution fee: funds sales and marketing expenses
• Service fee: funds ongoing shareholder account servicing, separate from marketing

What Are the 12b-1 Fee Limits?

FINRA's sales-charge rule sets these caps:

• Maximum distribution fee: 0.75%
• Maximum service fee: 0.25%
• Total maximum 12b-1: 1.00% (0.75% distribution + 0.25% service)

Under the SEC's mutual-fund distribution-fee rule, the plan must be in writing and the board, including a majority of independent (non-interested) directors, must approve it. If the fund adopts the plan after it has already offered its shares publicly, a vote of a majority of the fund's outstanding voting shares is also required.

Continuing the plan needs that same board-and-independent-director vote at least annually. The plan is terminable at any time, by a vote of the independent directors or by a majority of the fund's outstanding voting shares.

Try it: See how a 0.25%, 0.75%, or 1.00% 12b-1 fee compounds over a long hold with the 12b-1 Fee Impact Calculator.

What Is the Management (Advisory) Fee?

• Paid to the fund's investment adviser for portfolio management
• Typically the largest single ongoing expense
• Disclosed in the prospectus fee table

What Does the Expense Ratio Include?

Total annual operating expenses as a percentage of average net assets.

Expense Ratio = Annual Operating Expenses / Average Net Assets

Includes: management fees, 12b-1 fees, administrative costs, legal/audit fees

Does NOT include: sales charges (loads) or brokerage commissions on portfolio trades

Exam Tip: Gotchas

Expense ratio does NOT include sales loads. Loads are separate one-time charges not captured in the annual ratio.

How Do Breakpoints Reduce Sales Charges?

Volume discounts on front-end sales charges for Class A shares.

• Higher investment amounts = lower sales charge percentage
• Each fund sets its own schedule (disclosed in the prospectus)
• Breakpoint sale (selling just below a breakpoint threshold) is a regulatory violation

How Do Rights of Accumulation (ROA) Work?

• Existing holdings, usually valued at current NAV, count toward breakpoint levels for new purchases
• Includes holdings across accounts within the same fund family (e.g., all accounts holding American Funds, or all accounts holding Fidelity funds), regardless of account type: individual, joint, or custodial
• Usually valued at today's NAV, not what you originally paid: if your holdings have grown, the higher current value is what counts toward the breakpoint. A fund may instead value the holdings at original purchase price, or at the higher of the two; the fund's method is disclosed in its prospectus

How Does a Letter of Intent (LOI) Work?

• Non-binding pledge to invest a specified amount over a set period, usually 13 months, to qualify for reduced sales charges
• Most funds allow the LOI to be backdated up to 90 days to include recent purchases
• If not fulfilled, the investor must repay the discount already received; funds typically hold shares in escrow and redeem them to cover the difference
• The LOI is not a binding contract; the investor may choose not to fulfill it

Exam Tip: Gotchas

An LOI can be backdated 90 days and covers a 13-month forward period. If the investor fails to meet the stated amount, the fund recovers the discount, normally from escrowed shares. The fund's own prospectus sets the actual terms, because a fund may vary its sales load only on a schedule that it applies uniformly and describes in the prospectus and statement of additional information.

How Are Hedge Fund Fees ("2 and 20") Different?

• 2% management fee on total assets under management (AUM), charged regardless of performance
• 20% performance (incentive) fee on profits
• High-water mark: performance fee only charged on gains above previous peak NAV
• These fees are significantly higher than mutual fund/ETF fees

What Should You Check on Exam Day?

• Sales charges (loads) are one-time, on purchase or redemption; 12b-1 fees are ongoing and capped at 1.00% total (0.75% distribution plus 0.25% service).
• The 12b-1 plan needs board approval, including a majority of independent directors, renewed by that same vote at least annually, and it can be terminated at any time. A plan adopted after the fund's shares are already offered publicly also needs a shareholder vote.
• The expense ratio never includes sales loads or brokerage commissions.
• The management fee is usually the single largest ongoing cost.
• An LOI runs 13 months forward, can backdate 90 days, and is not binding. ROA usually uses current NAV and never expires.
• Hedge funds commonly charge "2 and 20," with the performance fee gated by a high-water mark.