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What is mutual fund timing, and why is it so bad?

Timing is the practice whereby traders try to profit from the short-term differences between daily closing prices. This is done with all types of securities. Whenever investors see the possibility of making a quick profit by buying low and selling high (or vice versa), they can do so.

Now, mutual fund timing is bad for investors in mutual funds because most often, investors are in it for the long term. But, by buying and selling the mutual fund in the short term, traders are increasing the associate costs of the mutual fund and passing these costs onto the long-term fund holders. Trading increases the costs for the long-term mutual fund investor because every time an investor buys or sells units of a mutual fund, the fund company must buy and sell the equal portion of the actual securities within the fund. With each transaction, there is a service charge (i.e. commission). These service charges eat into the returns of the people who are holding the fund for the long term.

Mutual fund companies are aware of the effects of timing and try to prevent it by adding on early-redemption penalties for those investors who redeem their investments before a minimum amount of time. These penalties transfer the costs of the transactions onto the short-term investor.


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