NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client is evaluating two mutual funds: Fund A has an expense ratio of 0.50% and a 12b-1 fee of 0.25%, while Fund B has an expense ratio of 0.75% and no 12b-1 fee. Both funds have similar investment objectives and historical performance. Assuming all other factors are equal, which fund would likely result in lower overall costs for the client?
- ABoth funds would have similar costs, as the differences offset each other.
- BCannot be determined without knowing the fund's turnover rate.
- CFund A, due to its lower expense ratio.
- DFund B, due to the absence of a 12b-1 fee.
Show answer & explanationAnswer & explanation
Correct answer: D. Fund B, due to the absence of a 12b-1 fee.
The total annual operating expenses for a mutual fund are the sum of its expense ratio and any 12b-1 fees. Fund A's total costs are 0.50% + 0.25% = 0.75%. Fund B's total costs are 0.75% + 0% = 0.75%. Therefore, both funds have the same overall costs.
Why the other options are wrong
- A. Fund A's total annual cost is 0.50% + 0.25% = 0.75%. Fund B's total annual cost is 0.75% + 0% = 0.75%. Thus, both funds have similar overall costs.
- B. The turnover rate affects transaction costs within the fund, but the question specifically asks about the 'overall costs' as represented by expense ratio and 12b-1 fees, which are direct annual investor costs.
- C. Fund A's total annual cost is 0.75% (0.50% + 0.25%), which is the same as Fund B.
Mutual Fund Expense Ratio & 12b-1 Fee
The expense ratio is the annual percentage of fund assets paid for operating expenses. A 12b-1 fee is an annual marketing or distribution fee charged as a percentage of fund assets.
- Both are ongoing annual costs to investors.
- Expense ratio covers management fees, administrative costs, etc.
- 12b-1 fees are for marketing, distribution, and sometimes compensating brokers.
- Total annual operating cost = Expense Ratio + 12b-1 Fee.
Memory trick: Expense ratio plus 12b-1, sum them up, your annual cost is done.