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 0.90% and no 12b-1 fee. Assuming both funds have similar investment objectives and performance before fees, which statement is TRUE regarding their total annual expenses?
- AThe 12b-1 fee is not a component of total annual expenses.
- BBoth funds have the same total annual expenses.
- CFund B has lower total annual expenses than Fund A.
- DFund A has lower total annual expenses than Fund B.
Show answer & explanationAnswer & explanation
Correct answer: D. Fund A has lower total annual expenses than Fund B.
Total annual expenses for Fund A are 0.50% (expense ratio) + 0.25% (12b-1 fee) = 0.75%. Total annual expenses for Fund B are 0.90% (expense ratio) + 0.00% (12b-1 fee) = 0.90%. Therefore, Fund A has lower total annual expenses.
Why the other options are wrong
- A. 12b-1 fees are a component of a mutual fund's total annual expenses and are always disclosed in the prospectus.
- B. Their total annual expenses are different (0.75% vs. 0.90%).
- C. Fund B's total expenses (0.90%) are higher than Fund A's (0.75%).
Mutual Fund Expense Ratio & 12b-1 Fee
The expense ratio is the annual percentage of a fund's assets paid for operating expenses. The 12b-1 fee is an annual marketing or distribution fee paid out of fund assets.
- Both reduce investor returns.
- Expense ratio covers management, administration.
- 12b-1 fee covers marketing, distribution, and sometimes advisor compensation.
- Total annual expenses include both.
Memory trick: Fees add up, so always sum up!