Buying, Redeeming, and Exchanging Mutual Fund Shares

1
Buying, Redeeming, and Exchanging Mutual Fund
Shares

• Chapter Outline
• Buying and Selling Fund Shares vs. stocks
• Public Offer Price
• Dollar Cost Averaging
• Automatic Reinvestment Plan
• Redeeming and Exchanging Shares
• Deciding Which Shares to Redeem

2
Buying and Selling Fund Shares

• Buying and Selling Fund Shares are not equivalent
  to buying and selling stocks
• Funds are redeemable securities, not tradable
  securities
• Fund shares can be purchased from and redeemed
  with the fund company itself
• Daily purchase price and sale price are
  determined at the end of the day. Process is
  different from common stock.

3
Buying and Selling Fund Shares

• Forward Pricing
• The calculation of a funds NAV at the end of
  each trading day after the securities markets
  close.
• No continuous intraday pricing of fund shares
• Buy or sell fund shares at the middle of the
  trading day, order is executed based on NAV at
  the end of that day
• Ask for price at the middle of the day, price
  quoted is the NAV from previous day.

4
Buying and Selling Fund Shares

• Why use Forward Pricing?
• Security prices are changing continuously during
  the day fund is receiving buy and redemption
  orders throughout the day.
• After the close of the trading day (400 p.m.
  EST)
• Mark to Market Based on the closing prices
• Subtract Expenses
• Recalculated NAV Net Value/Shares.

5
Public Offer Price

• When purchasing a share, order is executed as
  the funds POP.
• POP NAV/ (100 - Sales Charge)
• sales charge can vary from investor to
  investor (different classes of funds)
• Front end load offer quantity discounts.
• Fund with no front end load, POP is the same as
  NAV

6
Public Offer Price

• Example, page 105
• NAV 20.45, initial charges - 5.75
• POP 20.45/ (100 - 5.75) 21.70
• With a 1,000 investment,
• of Shares 1,000/21.70 46.08 shares
• A fund with 3 charges due to quantity discount
• POP 20.45/ (100 - 3.0) 21.08
• of Shares 1,000/21.08 47.43 shares.
• A fund with no front end load
• of Shares 1,000/20.45 48.9 shares.

7
Public Offer Price

• Investors can take advantage of break points by
• Lump-sum investment amount of investment to
  exceed quantity discount
• Purchasing shares under right to accumulation
  provisions.

8
Public Offer Price

• Right of accumulation
• Break point apply not only to a single fund, but
  to a fund family
• Front end load fund my allow investors to take
  advantage of lower discount when investment is
  approaching a breakpoint.
• This is accomplished with a Letter of Intent.
  LOI permits investors to receive a reduced sales
  charges for all investments during a fixed period
  of time.

9
Dollar-Cost Averaging
10
Dollar-Cost Averaging

• Since mutual fund price always fluctuates,
  instead of going straight up or down, the average
  cost is always less than average price.
• Cost less than price does not guarantee gain
• It works in both declining and rising markets
  benefits are enhanced when combined with dividend
  and capital gains reinvestment plan.

11
Dollar-Cost Averaging

• Disadvantages of DCA
• Limits profits during rising market
• If prices increase sharply with only small
  declines, average cost may be greater than
  average price. DCA will limit gains. Better off
  investing everything at one time.

12
Dollar-Cost Averaging

• Despite disadvantages, Investors may want to
  consider DCA
• Small investors do not have a large lump-sum
  amount to invest. Investors with modest income
  invest periodically for long term wealth
  building. DCA brings investment discipline.
• Initial purchase cost and average cost varies
  according to price fluctuation during the
  investment horizon
• Benefits of DCA varies from investor to investor
  depending on funds price change during the
  period of investment.

13
Automatic Reinvestment Plan

• Most funds allow investors to automatically
  reinvest dividends and capital gains.
• No legal requirement for funds to offer this
  benefit, but funds do because of competitive
  pressure
• A few front end load funds allow dividends to be
  reinvested at funds NAV and capital gains at
  higher POP
• Investors are responsible for all taxes in the
  calendar year
• Distribution in 401k, IRA etc., are tax exempt.

14
Redeeming Fund Shares

• For front end load funds, especially with no
  contingent deferred charges, fund simply buys
  back shares at the NAV and distributes the
  proceeds.
• For back end load funds, all charges are
  deducted from the proceed. The amount of
  deduction is based on the number of shares sold.
  The percentage deduction is calculated by the
  lesser of
• a) the original purchase price of the shares, or
• b) the NAV at the time of redemption.

15
Redeeming Fund Shares

• Example of Redeeming a back end load fund
• 1000 shares purchased 3 years ago at NAV of
  13.0 back end load begins at 5 and declines by
  1 each year to 0 current NAV 20.20 want to
  sell 50 shares what is the back end load?
• Total proceed (20.20x50) 1,010
• Load based on original purchase price
  3x13x50 19.50
• Net Proceed (1,010 - 19.5) 990.50.

16
Redeeming Fund Shares

• Load based on NAV at the time of redemption
  3x20.20x50 30.30
• Net Proceed (1,010 - 30.30) 979.70.
• Therefore, use original purchase price basis.
• If current NAV 12.0
• Load 3x12.0x50 18.0
• Use current NAV method.

17
Deciding Which Shares to Redeem

• Redeeming funds share has tax implications
• If redemption results in capital gains, pay tax
  during the year when the transaction occurred
• capital loss can be used to offset gains on
  another security.
• Tax planning is an important part of
  redemption
• Decide which share of your holding will be sold,
  because it will determine
• Cost basis of current sale and
• Tax on current sale.

18
Redeeming Fund Shares

• Three methods of selecting the shares for
  redemption
• First In. First Out. Shares purchased first will
  be redeemed first.
• Average Cost The fund computes the average
  purchase price of the shares being sold becomes
  the cost basis.
• Specific Shares Specify broker specific shares
  you want to sell according to their cost basis
• Once a method is decided, it must be followed.

19
Redeeming Fund Shares

• Example of Redeeming a back end load fund
• 1000 shares purchased 3 years ago at NAV of
  13.0 back end load begins at 5 and declines by
  1 each year to 0 current NAV 20.20 want to
  sell 50 shares what is the back end load?
• Total proceed (20.20x50) 1,010
• Load based on original purchase price
  3x13x50 19.50
• Net Proceed (1,010 - 19.5) 990.50.