What Is a Redemption Fee?
A redemption fee is a fee charged to an investor when shares are sold from a fund. This fee will be charged by the fund company and then added back to the fund. This fee may also be known as an exit fee, market timing fee, or short-term trading fee. It is typically instituted within a specified timeframe when an investor sells shares.
- A redemption fee is a charge imposed upon an investor when they sell their shares before a designated time period.
- When the redemption fee is collected, it goes directly back into the mutual fund.
- Shareholders pay a redemption fee in accordance with their amount of shares.
- Redemption fees help to discourage short-term trading.
How a Redemption Fee Works
A redemption fee is often associated with a mutual fund. When an investor sells shares from the fund, a redemption fee can be charged by a fund company. Mutual funds are typically part of a long-term investment strategy and they are not usually intended for short-term trading or gains from market timing. In addition, they are spread across the fund shareholders in accordance with the amount they have invested. This setup promotes fairness surrounding these fees.
For this reason mutual fund timing, although legal, is a frowned-upon practice that usually results in an additional charge for the investor. To discourage short-term trading, fund companies will typically charge a redemption fee within a specified timeframe. Most fund companies use a timeframe of 30 days. If an investor exits the fund within 30 days of their initial purchase then a redemption fee could be charged. The redemption fee is charged upon exit as opposed to depositing in the mutual fund as they don’t want to discourage deposits.
Before acquiring shares in a mutual fund, check on redemption fees and make sure to avoid paying the fee by not engaging in short-term trading.
Redemption fees can result in mutual fund timing being subjected to higher fees occasioned by the transaction costs of the short-term trading of fund shares. Investors are typically not charged for redeeming shares of the investment if it’s outside of the designated minimum time requirement. With that said, it’s important to be aware of any redemption fees and timeframes associated with them.
Redemption fees are necessary to protect other investors from higher transaction costs. Active short-term redemptions lead to two significant issues for the fund manager including:
- The fund is required to maintain higher cash positions to accommodate sell orders.
- Short-term trading increases the overall operating costs of the fund.
Therefore, in order to keep cash positions and operating expenses lower, the fund may enact a redemption fee.
Example of a Redemption Fee
Mutual fund investing can involve numerous fees throughout the investment duration. Other fees involved may include sales loads, 12b-1 fees, and account service fees. Investors should ensure they understand all fees involved before buying and selling a mutual fund.
Vanguard mutual funds do not broadly include redemption fees however they are required in some of the fund company’s mutual funds. The Global ex-U.S. Real Estate Index Fund Investor Shares (VGXRX) is one example. This fund has a purchase fee and a redemption fee to support the expenses of the fund. VGXRX charges a purchase fee of 0.25% and a redemption fee of 0.25%.