Buying and selling mutual funds works a bit differently from buying and selling shares of stock or ETFs. When a mutual fund is sold, it is called a redemption. Mutual funds typically keep cash reserves to cover investor redemptions so they aren't forced to liquidate any portfolio holdings at inopportune times.
But what happens when investors want to take that step and redeem their shares? The process is actually quite simple.
- When an investor sells mutual fund shares, the redemption process is straightforward, but there might be unexpected charges or fees.
- Class A shares usually have front-end sales loads, which are fees charged when the investment is made, but Class B shares may impose a charge when shares are sold.
- Some mutual funds charge early redemption fees to discourage short-term trading.
- An exchange fee is a fee charged when an investor swaps one mutual fund for another with the same fund family.
- Investors might owe taxes when capital gains are realized on the sale of fund shares in a taxable account.
Understanding What Happens When You Liquidate Mutual Funds
Mutual fund shares are priced once the market closes every day at 4 p.m. unlike stocks, which trade on an intraday basis. Once the closing bell rings, the net asset value (NAV) of each mutual fund is calculated. With most redemptions, the proceeds are distributed to the investor on the following business day.
But redeeming your mutual funds may trigger certain consequences. You may not be aware of some of the downsides, like the costs that can eat away at your anticipated returns. All of these should be noted down in the fund's prospectus, so it's important for you to read it and understand all of the financial implications before buying, selling, or exchanging mutual fund shares.
Mutual Fund Share Classes
Many mutual funds offer several classes of shares, such as Class A and Class B, and Class C shares. Each share class owns the same fund securities but has different fees and expenses. As such, you can choose the fee and expense structure that best suits your investment goals.
- Class A shares typically impose a front-end sales load, which is a charge the fund uses to compensate brokers.
- Class B shares do not have a front-end sales load, but they may impose a deferred sales load charge when mutual fund shares are sold.
- Class C shares may have either a front-end load or a back-end load, but these charges tend to be lower than for Class A or B shares.
A typical front-end load charge could be 4% of the initial investment and cannot exceed 8.5%. The front-end load percentage may decrease as the size of the investor's purchase increases. Back-end sales load charges cannot exceed 8.5%, and this percentage will decrease over time until it reaches zero. Long-term investors might select Class B shares when they anticipate holding the fund shares for long periods of time. All three share classes also impose a range of shareholder fees and expenses.
No-load funds do not charge fees for buying or selling shares. But just like load funds, they do charge other fees and expenses that can lower your returns.
The cost of buying, owning (and selling) mutual fund shares is something many investors don't think about, especially when they first start investing. Actively-managed funds tend to have higher fees because of the time fund managers take to reallocate the portfolio. Passively-managed ones, on the other hand, tend to come with lower fees.
We break down some of the most common fees associated with selling your shares below.
Shareholder fees are any charges that you pay when you buy or sell fund shares. These are typically one-time costs. They include the mutual fund's operating expenses such as:
- Investment advisory fees
- Marketing Fees
- Distribution 12b-1 fees
- Other administrative expenses
A fund's 12b-1 fees are paid out of the fund's assets, which means you pay these charges indirectly. They cover the expenses for marketing and selling fund shares, including advertising costs, broker compensation, and printing and mailing of prospectuses and sales literature.
Early Redemption Fees
Some mutual funds charge early redemption fees to discourage short-term trading. These fees generally take effect for holding periods ranging from 30 days to one year.
Early redemption fees are paid directly to the funds and are separate from potential back-end load charges, which are paid to the broker. The Securities and Exchange Commission limits redemption fees to a maximum of 2%.
Keep in mind that you may have to pay these fees in addition to back-end loads, which are a percentage of the total value being liquidated. Class B and Class C shares normally charge investors back-end sales loads.
Some fund companies give their investors an exchange privilege. This benefit allows you to exchange your funds for other ones within the same family when the market changes course. Depending on the fund company, you may or may not be charged a fee for swapping out your funds.
A mutual fund can impose an exchange fee when you replace shares in one fund for shares in another within the same fund family. An exchange is a taxable event, which means that you can be liable for any capital gains on the sale/exchange of the shares as well.
You can find out if the fund company charges any exchange fees (and others, for that matter) in the prospectus.
Just like any other investment, there are tax implications associated with buying and selling mutual fund shares. The value can change from the time you made the investment. If you end up with a positive return, you have to pay capital gains. You realize a capital loss if the value of your shares drops from the time you purchased them.
If you hold mutual fund shares in a taxable account, you may owe tax on any net capital gains that you realize from the sale of your fund shares during the calendar year. You may also have to pay taxes on your proportionate share of the fund's capital gains.
The law requires a mutual fund to distribute capital gains to shareholders if it sells securities at a profit that cannot be offset by losses. These distributions take place close to the end of each year.
How Long Do You Have to Hold a Mutual Fund Before Selling?
You're allowed to sell your mutual fund holdings at any time after buying shares. But there may be consequences based on the type of mutual fund you own. For instance, some fund companies charge an early redemption fee if you sell your shares before a prescribed period of time. This is in addition to any back-end load fees (if any) that some funds charge when you sell your holdings.
What Fees Do Mutual Funds Charge When You Sell Shares?
Some mutual funds charge fees if you decide to sell your shares. For instance, you're responsible for a percentage of the total amount of shares you're selling. This is known as a back-end load fee. Often a flat fee, the back-end load tends to decrease over time. Most funds also charge early redemption fees, which are imposed on investors who cash in their shares before a certain period of time.
What Price Do I Get When I Sell a Mutual Fund?
The sale price for mutual fund shares is the next available net asset value. This is determined once the market closes. So if you put in a redemption request at 2 p.m. today, the net asset value used to calculate your payout is posted at the end of the trading day. If you make a request on a weekend or after hours, the NAV is determined at the end of the next trading day.
How Do I Compute Capital Gain When Selling Mutual Funds?
Capital gains (or losses) are computed as the buying price less the selling price, taking out any costs such as sales loads or commissions from both sides of the transaction. Holding periods of less than one year are taxed as short-term gains/losses and over a year at the more favorable long-term capital gains rate.
Are There Hidden Expenses When Liquidating No-Load Mutual Funds?
No-load mutual funds do not have a sales commission involved when you buy or sell. However, funds with a high turnover of the assets held in their portfolios may generate taxable events. What's more, is a loss on a position in a mutual fund cannot be used to offset gains elsewhere for an investor, while gains are always taxable. According to a recent Morningstar study, the average cost of mutual fund tax inefficiency is approximately 1.10% per year. These more actively-managed funds may also generate transaction costs as they buy and sell securities, which are passed onto the fund's shareholders.
The Bottom Line
Mutual funds can be a great way to diversify your portfolio. They pool money together from multiple investors and invest it into related stocks, bonds, and other assets. So if you're interested in blue chips but don't want to look for individual stocks. a mutual fund may be the right option for you. As an investor, you will have to educate yourself about the consequences of liquidating your fund shares because there may come a time when you'll have to sell your holdings. This means being prepared to pay fees and taxes. Knowing what you owe ahead of time can make you an investor who's better prepared for the future.