Fund TradingMutual Funds
The pricing of many mutual funds is their Net Asset Value, shortened to NAV. Net Asset value is the net worth of the fund, calculated as total market value of assets minus its liabilities. NAV is updated at the end of each trading day when the investments owned by the fund reach their final day price. A Mutual fund trading at NAV pricing use “Late Trading”, which means that the funds themselves only execute buy and sell orders when prices are static. Unlike stock and bonds, which allow you to liquidate your holdings in as little as 10 minutes if you have a trading partner, mutual funds will only allow you to trade daily after markets have closed.
Fund Trading: Entering & Exiting
Funds are still easy to enter and exit, even with the restriction in trading hours. Buy and sell orders accrue during the day until trading hours have finished. After close, they will be executed at that day’s closing Net Asset Value. This results in serious limitation to your fund holdings. If you are watching a market crash occur in real time, you will not be able to exit a fund with falling values. If you are watching a market rally you won’t be able to purchase a fund to capture gains. Your orders will take place at the end of the trading day when net asset value has already been adjusted to market movements.
Fund Trading: Order Delay Execution
There are some stricter regulations that exist for trading mutual funds as well. If you place a buy or sell order during the trading day your order will be honored after the market’s closure. If your order is after hours, on holidays, or during a weekend, it will be honored at the end of the next trading day. This regulation prevents investors from purchasing funds at current net asset values when price and NAV changing information has been released after-hours. Net Asset Value is often updated during after-hours with preliminary price changes based on how foreign markets were affected. The historical impact of similar news on NAV is also reviewed before making changes. All of these restrictions are placed on funds by market regulators; check your local regulations to prevent confusion in trading restrictions.
Fund Trading: Restrictions
Mutual funds may place restrictions on buying or selling the fund’s shares. If the fund is under high demand, and investors are flooding the fund with more cash than it can invest in a reasonable time, the fund may block new investors. Blocking new money from entering the fund reduces their cash drag. Cash drag occurs when liquid cash or money market instrument’s small average returns reduce overall performance measurements. Both asset categories have low returns compared to the active investment market. In redemption pools, the cash is used to redeem shares being sold back to the fund for profit. This allows management teams to gain control of the financial situation before reduced performance affects investors within the fund.
Fund Trading: Limits and Lockouts
Many funds attempt to block traders attempting to buy and sell fund shares in rapid succession. If you previously invested in the fund and exited, managers may stop you from reentering for a specific period of time. Allowing rapid entry and exit disrupts the cash redemption pool. This pool pays investors selling fund shares back to the fund. Allowing frequent purchases and sales results in redemption pools being drained and then overfilled. This can potentially destabilize fund returns. If there is not enough cash in the redemption pool the fund is required to sell securities to meet redemptions. This disrupts investments that would earn existing investors return. Some funds charge redemption fees or additional premiums for investors attempting to reenter a fund after a recent sale. Proceeds from these fees are used to compensate investors for any disruptions generated by redemptions.
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