While we've been quietly going about our business from day to day, our friends in the mutual fund industry have been adding redemption fees to their funds. More than ever, investors need to watch out for these fees, lest they get socked by them.
A redemption fee is charged when you redeem, or cash in, your shares. These days, funds are increasingly charging investors if they withdraw their money after being in a fund for less than a specified minimum period. The period might be as short as a week or, in some cases, as long as a year. Periods of one to three months are more common, and the fees tend to be around 1% to 2%. According to Lipper Inc., since the beginning of 2003, more than 1,000 mutual funds have introduced redemption fees.
The bad news is that some investors, especially those caught unaware, may get whacked with significant fees if they redeem their shares too early. On a $10,000 withdrawal, a 2% fee amounts to $200. Many of us are likely shrugging, thinking, "As good long-term Fools, we wouldn't want to sell out of a fund we just bought into for quite a while, so bring on the restrictions." That's fine -- and even Foolish. But what if an emergency happens and you're not prepared? (Heaven forbid! Prepare yourself, please!) If you unexpectedly have to sell prematurely, you'll be penalized. (Some funds permit fee waivers for emergencies.)
There's a good side to the fees, though. The fees are being supported by the Securities and Exchange Commission (SEC) because they can deter market-timers, who have profited at the expense of fund shareholders by quickly buying and selling shares of funds to take advantage of differences between outdated and current prices. The redemption fees collected are meant to be reinvested in the fund, which can also help shareholders.
The fees help fund companies by reducing administrative work when share turnover drops. Long-term investors are simply less expensive to service. Noticing this, now some 401(k) plans are following suit, restricting how frequently account holders can trade by imposing fees.
Critics say that the fees aren't high enough -- that market-timers and others stand to earn more than 2%, so they'll ignore the fees. Some have proposed tiered fees, as high as 6% for ultra-quick withdrawals and 2% for longer-term ones. We'll see what ultimately happens, but for now, make sure you know about any redemption fees for your fund holdings before you sell.
The mutual fund industry is probably more interesting than you think. Learn much more about it at our Mutual Fund Center and from index fund pioneer John Bogle. And while you're at it, take advantage of a free trial of our new Motley Fool Champion Funds newsletter, which delivers recommendations of outstanding mutual funds each month.
Lo ngtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.