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)
• CDSC schedule: The rate declines with each year the shares are held, then reaches 0%. For example, 5% in year 1, 4% in year 2, 3% in year 3. Read the rate for the year of redemption; do not average the rates or count points down yourself.
• 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

What happens when assets fall? The management fee is usually a percentage of average net assets, so it shrinks with the fund. Other costs, such as custody, audit, legal, board, and administrative expenses, are largely fixed in dollars. After heavy net redemptions, those fixed dollars are divided by fewer assets, so the expense ratio usually rises.

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 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
• Each fund sets its own method and discloses it in its prospectus: holdings may count at current value (NAV or maximum offering price), at total purchases at the prices paid, or at the higher of the two. Under current value, holdings that have grown count at the higher figure

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
• Many funds allow backdating to include recent purchases, usually up to 90 days; the fund's prospectus sets the actual lookback and purchase eligibility
• 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

13 months and a 90-day lookback are usual LOI terms, not universal requirements. Only purchases eligible under the fund's disclosed terms count toward the target. 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 vote at least annually, and is terminable at any time. A plan adopted after a public offering also needs a shareholder vote.
• The expense ratio includes the management fee, usually the largest ongoing cost, but never sales loads or brokerage commissions.
• An LOI is non-binding and usually covers 13 months; permitted lookbacks are usually 90 days. The prospectus sets the terms. ROA values holdings by the method the prospectus states and never expires.
• Hedge funds commonly charge "2 and 20," with the performance fee gated by a high-water mark.