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

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.

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.

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 (4:00 p.m. EST) Mark to Market: Based on the closing prices; Subtract Expenses; Recalculated NAV: Net Value/#Shares.

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

Public Offer Price Example, page 105 NAV $20.45, initial charges % POP = [$20.45/ (100% %)] = $21.70 With a $1,000 investment, # of Shares = $1,000/$21.70 = shares; A fund with 3% charges due to quantity discount: POP = [$20.45/ (100% - 3.0%)] = $21.08 # of Shares = $1,000/$21.08 = shares. A fund with no front end load: # of Shares = $1,000/$20.45 = 48.9 shares.

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.

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.

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.

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.

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.

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.

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.

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 = 3%x$13x50= $19.50 Net Proceed = ($1, ) = $

Redeeming Fund Shares Load based on NAV at the time of redemption = 3%x$20.20x50= $30.30 Net Proceed = ($1, ) = $ Therefore, use original purchase price basis. If current NAV = $12.0 Load = 3%x$12.0x50 = $18.0 Use current NAV method.

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.

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.

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 = 3%x$13x50= $19.50 Net Proceed = ($1, ) = $