Friday, August 17, 2007

Beware fund redemption fees

Mutual funds have had trading restrictions and redemption fees to prevent market-timing for a while now. For example, fund investors may be prevented from making a round trip (purchase and sale) of a fund within 90 days, or they may be hit with a 1-2% redemption fee for selling a fund within 30 days of a purchase. 401(k) plan investors may have been avoiding these restrictions and fees in the past, but that is changing (free WSJ Digg link).

The short version of what's happening:

While redemption fees and trading restrictions aren't new, some investors have been able to avoid these penalties if they hold funds through an "omnibus" account such as a 401(k) plan, which can make it tough for fund companies to detect who's trading and how often. The new rule, which was issued by the SEC in early 2005 after the effects of widespread market-timing became well-known, helps fund companies to peek inside these omnibus accounts and enforce their short-term trading restrictions.
Rules are hitting those who aren't market-timing

But applying these rules are having unintended consequences:

One 47-year-old participant in the plan had a portion of his account automatically switched into the Artisan International Fund. But one week later, he decided to adjust his allocation and moved more than $24,000 from the Artisan fund into a real-estate fund. The participant, who has made only three other trades this year, is hardly a market-timer, Mr. Kaye says. But his move cost him nearly $500 because the Artisan fund charges a 2% redemption fee on shares held less than 90 days.

The participant "felt the system was gamed against him and initially was very resentful," Mr. Kaye says.


In some cases, retirement-plan participants making regular rebalancing trades -- a practice advocated by many financial advisers -- have been flagged by fund companies as potential abusive traders. In plans provided by ePlan Services Inc., a 401(k) administrator and recordkeeper based in Denver, two participants making regular rebalancing trades were singled out by fund companies for potential trading abuses in the past 90 days, says Mark Gutrich, ePlan's president and chief executive. The firm spent hours researching their trades and calling the participants and ultimately convinced the fund companies that the trades weren't abusive, Mr. Gutrich says.
How to not fall into this trap

To avoid this conundrum, I read and understand the fund's prospectus. The restrictions and fees are all disclosed in the prospectus. My own 401(k) plan has several restrictions on a few of the funds it offers. I make sure I understand the round trip rules and redemption fees. It seems that at least once a year the plan sends me another note about another short term trading restriction being put in, so I don't ignore any notices I'm sent.