When investors redeem mutual fund shares, the process is very simple. Mutual fund shares do not trade intraday. Instead, the shares are priced at the close of the market at 4 p.m., when their net asset value (NAV) is calculated. Mutual funds typically keep cash reserves to cover investor redemptions so that they will not be forced to liquidate portfolio securities at inopportune times. With most mutual fund redemptions, the proceeds are distributed to the investor on the following business day.
There are consequences that can be triggered when mutual fund shares are redeemed, yet many investors are not aware of these events. Examples of these consequences include fees, charges, commissions and expenses that reduce an investor's anticipated return. All of these charges are described in a fund's prospectus. It is important that investors read a fund's prospectus to 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" shares. Each share class owns the same fund securities but will have different fees and expenses. Investors can choose the fee and expense structure that best suits their 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 the 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, but it 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.
It is important to note that no-load funds do not charge fees for buying or selling shares, but, as with load funds, they do charge other fees and expenses that can lower a shareholder's return.
Shareholder fees include the mutual fund's operating expenses such as investment advisory fees, marketing and distribution (12b-1) fees and other administrative expenses. The 12b-1 fees are paid out of the fund's assets, which means investors are paying these charges indirectly. The 12b-1 fees 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. Generally, these fees take effect for holding periods ranging from 30 days to one year. The early redemption fees are paid to the funds, and are separate from potential back-end load charges, which are paid to the broker. The SEC typically limits redemption fees to a maximum of 2%.
A mutual fund can impose an exchange fee when a shareholder exchanges shares in one fund for shares in another fund within the same fund family. An exchange is a taxable event, which means that the investor can be liable for any capital gains on the sale/exchange of the shares.
An investor holding mutual fund shares in a taxable account, may owe tax on any net capital gains realized from the sale of his fund shares during the calendar year. In addition, he may also have to pay taxes on his 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.