Here's the offer:
"Receive up to a 50% rebate on your 12b-1 fees… these are fees paid by many mutual funds to brokerage firms to cover the costs of marketing and selling funds shares…See our list of funds on which you can receive a rebate."
From there they show you a list of funds they offer with 12b-1 fees and the approximate kickback you will receive for buying each fund.
A Noble Effort
Mutual fund fees are under scrutiny by industry regulators, congress and the press. As I've written before, 12b-1 fees are the darkest secret in the mutual fund industry. E-trade noticing this trend, decides to be the first brokerage to offer rebates on the 12b-1 fees that are paid to them and if this were their primary motivation, I applaud them for that. However, what may seem like a noble effort, is really a wolf in sheep's clothing.
The Truth
The truth is, there is no need for investors to ever pay a 12b-1 fee. The SEC initially allowed 12b-1 fees to help a struggling mutual fund industry by shifting the burden of marketing and administration costs directly to the fund shareholders. It turns out the mutual fund industry didn't struggle at all (there are now more mutual funds than stocks) and 12b-1 fees are abused by some fund companies and the brokers who receive them.
In theory, the 12b-1 is collected to attract new investors to allow for economies of scale, which would lower the costs of running a fund. In practice, only about 5 percent of the 12b-1 fee actually pays for advertising - most of the 12b-1 fee goes to the broker who sold the fund to you. Funds continue to charge 12b-1 fees despite economies of scale and some closed funds continue to charge the 12b-1 fee even though they don't allow new investors!
As I explained in a previous 12b-1 fee article, these fees don't help your investments in any way. You gain no advantage by paying these fees and most funds even offer a version of the fund that carries no 12b-1 fees. 12b-1 fees are essentially a yearly tax on mutual fund dummies, directly payable to the person who sold them.
Encouraging Bad Behavior
Instead of fighting 12b-1 fees, the E-trade offer actually encourages investors to choose funds that carry a 12b-1 fee. The way the offer and FAQ's are written, plus the way they provide you a list of funds to shop for that include 12b-1 fees, it is painfully obvious that E-trade is using 12b-1 fees rebates as a way to coax investors into buying loaded funds. E-trade goes to great lengths to show you exactly how much money you will get back buy purchasing a certain fund.
The math is very simple. For example, if you invest $10,000 in a no-load fund, you will have $10,000 in your account. If you invest $10,000 in a loaded fund, you will only have $9,500 in your account due to an up-front sales fee, plus we will take out an additional 1% each year, but don't worry, we'll give you 1/2 of a percent back, which could be a taxable event.
E-trade's Reason for Doing This
E-trade claims: "At E*TRADE Securities, we built our reputation by being an advocate for the individual investor. We helped pioneer online investing and, as a financial services industry innovator, we leverage technology to maximize efficiencies and keep our costs low. We constantly seek opportunities to break new ground and pass along any savings to our customers."
My Perspective
I've never had anything against E-trade in the past, but this definitely pushes my buttons. I'm afraid many current and potential customers of E-trade are being taken advantage of. Technically, current customers who are already paying 12b-1 fees will be better off, but instead of encouraging them to use no-load funds, E-trade encourages them to move to funds with even higher 12b-1 fees.
The ads should really read "If you let us steal $500, we will give you $250 back."
