The sale of units within a mutual fund results in what is called "redemption." When it comes to redeeming the units of a mutual fund, the investor makes the decision as to whether or not to redeem their earnings. However, there may be some issues that come into play that can prevent this redemption, which includes a minimum holding period.
If a minimum holding period is in effect and a person tries to sell before that period is up, they are not going to be able to do so. But if that minimum period is up, then a person is free to redeem. When an investor makes a request to redeem, the mutual fund company must make sure it happens within seven days of that request.
When choosing to redeem, you may want to evaluate which units you want to sell because there may be redemption fees. These fees may dictate your decision, especially if you want to save some money on fees. So you should make sure you're reading a prospectus to know what those fees are.
The redemption fees will be collected by the investment company. The purpose of fees is to discourage redemption in the short-term. Because a mutual fund consists of investments by a pool of investments, it works in the best interest of all investors to discourage in-and-out trading. There may also be a time period on any fees that are charged.
An example of the time period a fee may be charged, it is in your mutual fund's prospectus regarding the fees that you will be charged if you redeem. You will notice that there is a holding period. This can be anywhere from 30 days to a year in which redemption fees can be charged. It is not uncommon for the holding period to be longer.
Redemption fees may also be called "exit fees" because you are exiting in some way from the fund. Even if you do not sell all shares, you are still selling some of the shares and there is a penalty to be had for that. These fees are in addition to any other selling fees that are associated with the transaction.
If you are someone who likes to sell on the short-term, you may be considered someone who practices mutual fund timing. This means you are selling when you know you are making a profit. However, the fees are imposed so that you may have second thoughts about redeeming too soon. Although this is a legal practice, it is one that is not liked to well amongst mutual fund managers, which is why the redemption fees tend to be higher.
After the holding period has come and gone, any fees that you are charged for redemptions, if any, are not taken by the investment company, but will be applied to the assets of the mutual fund. When you wait until the holding period is over, you can expect the fees to be considerably less. That is because the holding period is the desired amount of time for you to wait to redeem.
Mutual fund timing is when investors make an attempt to gain through the buying and selling of mutual fund shares in the short-term. The idea is to benefit between the daily closing price differences. This is different than market timing, which is not frowned upon, because it involves predicting the best time to buy and sell.
The reason why mutual fund timing is not preferred is because it has a negative impact on the fund's investors. That is why the penalty can be quite stiff. These stiff penalties sometimes serve as a sufficient deterrent.
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