A Fund Fee We Love

June 22, 2006

Nobody hates mutual funds fees more than we do. At MAXfunds.com, we absolutely hate loads, deplore high expense ratios, and barely tolerate 12b-1 fees. So you'd think when the Securities and Exchange Commission ruled last year to continue to allow mutual fund companies to charge shareholders for selling shares of a fund (up to 2% in redemption fees) that we'd be hopping mad. But we're not. In fact, we're actually tickled pink. Redemption fees, you see, are the ones we absolutely love.

Redemption fees are charged by some funds if an investor sells a position held for less than a certain period of time. The amount of the fee and the redemption fee period varies from fund to fund, but a common redemption fee is 1% of sales made within 90 days after purchase.

Redemption fees do bear a strong resemblance to back-end loads (or contingent deferred sales commissions or CDSCs), which we hate. So why are we in favor of a fee that seems to do just about the same thing? Because redemption fees discourage short-term investing - the practice of hopping in and out of a fund to benefit from quick rises in NAV prices.

Besides the fact that we think short-term mutual fund investing is, in the long run, a losing game for you as an investor, people switching in and out of a fund hurts the shareholders who remain in a fund. Such "hot money" raises a fund's expenses because of increased transaction costs and, more importantly, presents a fund manager with the problem of a fluctuating asset base that makes it tougher to stick to his chosen investment strategy. Redemption fees make short-term investing (in funds that charge them) prohibitively expensive.

Another important difference between back-end loads and redemption fees is that the money generated by the load goes into the pocket of the broker or fund manager, while redemption fee money goes go back into the pot held by other shareholders. This redemption fee money offsets the trading costs that are run up by short-term shareholders but paid for by long-termers.

Redemption fees can, of course, hurt investors who might have a legitimate need to sell shares of a fund before the redemption period has expired. A loss of employment or a natural disaster like hurricane Katrina could necessitate an unforeseen fund sale, but there are currently no exemptions offered by redemption fee-charging fund companies for such emergency sales.

Despite the loss of flexibility caused by redemption fees, we think fund investors should look at redemption fees as positives when evaluating a mutual fund for purchase. The managers behind MAXadvisor Private Management and the MAXadvisor Powerfund Portfolios certainly do when assessing funds for their fund portfolios. You can find out if a fund you are considering buying (or selling) charges a redemption fee by checking the fee table of the fund's prospectus
As an investor you must be sure you hold a fund long enough to avoid the fee. Nobody tells you when you are about to make a sale that will incur a redemption fee - it's up to you to keep track of your fund's purchase date and redemption period.