What Are Service Shares?

The term service shares refer to mutual fund units or shares that charge shareholders an extra fee to cover the cost of responding to investor inquiries and other services. These fees are referred to as shareholder service fees. The Financial Industry Regulatory Authority (FINRA) limits service shareholder fees to no more than 0.25% of the fund’s average net assets per year.

Key Takeaways

  • Service shares are mutual fund units that charge shareholders an extra fee to cover the cost of responding to investor inquiries and other services. 
  • These fees are referred to as shareholder service fees.
  • Service share fees are one part of a fund's 12b-1 fees, which are named after a section in the Investment Company Act of 1940.

How Service Shares Work

A mutual fund is a popular type of investment that pools money together from multiple investors and spreads it across different assets such as stocks, bonds, cash, money market accounts, and other investment vehicles. These funds are managed by mutual fund companies that employ money managers to oversee individual funds. Depending on the type of fund—whether active or passive—managers use specific strategies and may reallocate holdings in order to generate income for their investors.

Fees are an integral part of the mutual fund industry, with two common groups of fees. The first consists of shareholder fees. These charges cover things like one-time costs and commissions paid when investors purchase shares. Shareholder fees include account fees, purchase fees, redemption fees, and sales loads. The other category of mutual fund fees consists of annual operating expenses, which include management fees, administrative costs, and 12b-1 fees.

These fees are named after a section in the Investment Company Act of 1940. At the time of the act, many believed that 12b-1 fees—including service share fees—were a net positive for investors. A well-marketed mutual fund is also believed to attract more investors, acquire more assets, and ultimately lower expenses per share. That's because unit costs tend to drop due to economies of scale.

A mutual fund's 12b-1 fee covers service shares. These are shares that cover costs that are related to any marketing or sales of the fund itself. Service shares charge fees to shareholders to compensate individuals who answer investors’ questions and give them information about the investments in the mutual fund. The Securities and Exchange Commission (SEC) refers to these fees as shareholder service fees. As noted earlier, these fees can amount to no more than 0.25% of a mutual fund’s average annual net assets.

A mutual fund's service shares fees may not exceed 0.25% of its average net assets per year.

Special Considerations

A sales load is a fee a mutual fund may charge as a commission for the brokers. Some mutual funds advertise themselves as no-load mutual funds, meaning that they don’t impose a sales load, deferred or otherwise. That does not mean the fund charges no fees. It will still use fund assets to cover annual operating expenses and may impose other fees they charge directly to shareholders.

Even no-load funds may charge a fee to shareholders for redeeming their shares too early. FINRA states that a mutual fund cannot classify itself as no-load if 12b-1 fees, service fees, distribution fees, and marketing fees add up to more than 0.25% of average net assets per year.

Like all mutual fund fees, shareholder service fees eat into returns, and investors should study the fund’s prospectus to determine whether the mutual fund’s returns are worth the fees. A popular investment strategy is to seek out low-fee investments on two dovetailing premises, that fees are certain while returns are not and that actively managed mutual funds often underperform the market and, by extension, also underperform passively managed index funds.