A company that invests in bonds, stocks or other assets with money brought together from many people is a mutual fund as defined by the U.S. Securities and Exchange Commission, according to the Forbes website. Purchasing a mutual fund secures a piece of the fund but not any of the actual assets owned by the mutual fund. The sale of a mutual fund is known as a redemption.
Mutual funds differ from stock trading in that you can only trade mutual funds at the end of the market day as the mutual funds are based on their net asset value (NAV) which is determined at the end of day. To counteract this inflexibility, mutual fund companies allow shares of the mutual funds to be purchased which is called fractional trading, according to the forbes.com website. While mutual funds can be sold from person to person if the owner sells his portion of the mutual fund back to the fund it is known as redemption.
Assets and Benefits
The value of the mutual fund is based on the value of the assets, according to the forbes.com website. The fund fluctuates in value as the bonds and stocks increase or decrease in value. Professional management and diversification are key benefits of mutual funds. The value of the diversified investments determines the redemption value for the mutual fund if it is sold back to the mutual fund.
Mutual funds without cash require a fund manager to sell the appropriate amount of shares to cover the redemption and of course someone to buy the shares, according to the website The Investment FAQ. Every dollar redeemed in an open-end mutual fund is not necessarily replaced by an invested dollar. Also a redemption fee may be applied if funds are sold before a stipulated date. Redemption fees are established by fund companies to discourage early turnover in the mutual fund.
An issue occurred when short-term trading caused harm with certain mutual funds because the traders were seeking to make a quick profit, according to the website fnbnd.com. This brought about the need for mutual fund companies to maintain cash to cover these sales and also numerous short-term trades increase operating costs which serve to penalize long-term investors. The redemption fees were imposed in an attempt to limit the number of short-term trades and encourage long-term investors.
Amount of Fee
Mutual fund redemption fees will vary from company to company, according to the fnbnd.com website. The “first in, first out” (FIFO) method of determining shares subject to redemption fees is based on the premise that shares bought first are redeemed first and conversely shares bought last are redeemed last. In order to benefit the long-term investor, redemption fees are reinvested in the mutual fund.