A Guide to Mutual Fund Trading Rules

Investing in mutual funds isn't difficult, but it isn't quite the same as investing in exchange traded funds (ETFs) or stocks. Because of their unique structure, there are certain aspects of trading mutual funds that may not be intuitive for the first-time investor. Notably, many mutual funds impose limits or fines on certain types of trading activity, due to past abuses.

A basic understanding of the ins and outs of mutual fund trading can help you navigate the process smoothly and get the most out of your investment in mutual funds.

How to Buy Mutual Fund Shares

Mutual funds are not traded freely on the open market as stocks and ETFs are. Nevertheless, they are easy to purchase directly from the financial company that manages the fund. They also can be purchased through any online discount brokerage or a full-service broker.

Many funds require a minimum contribution, often between $1,000 and $10,000. Some are higher, and not all funds set any minimum.

You also may notice that some mutual funds are closed to new investors. The more popular funds attract so much investor money that they get unwieldy, and the company that manages them makes the decision to stop enrolling new investors.

Doing Your Research

Before you make a decision, you'll want to do your research to find the fund or funds that you want to invest in. There are thousands of them, so there's plenty of choice out there.

These have a wide range to appeal to the many types of investors, from "conservative" funds that invest only in blue-chip stocks to "aggressive" and even speculative funds that take big risks in hopes of big gains. There are funds that specialize in particular industries and in certain regions of the world.

There also are many choices beyond stocks. Don't forget bond funds, which promise steady payments of interest and low risk.

Keep in mind that most funds don't put all their eggs in one basket. A percentage of the fund may be reserved for investments that balance the portfolio.

Best Sources of Information

Your first stop should be the website of the company that manages the fund. Companies like Vanguard and Fidelity provide a wealth of information on every fund they manage, including a description of the fund's goals and strategy, a chart showing its quarterly returns to date, a list of its top stock holdings, and a pie chart of its overall composition. All expenses and fees also will be listed.

A further search of financial news websites can get you insight into the fund and its competitors from analysts and commentators. If you use an online broker, you'll find additional information on its site, including risk ratings and analyst recommendations.

If it is an indexed fund, check its historical tracking error. That is, how often does it beat, match, or miss the benchmark that it aims to outperform?

As with any investment, you need to know what you're getting into.

When to Buy and Sell

You can only purchase mutual fund shares at the end of the trading day.

Unlike exchange-traded securities, mutual fund share prices do not fluctuate throughout the day. Instead, the fund calculates the total assets in its portfolio, called the net asset value (NAV), after the market closes at 4 p.m. Eastern Time each business day. Mutual funds typically post their latest NAVs by 6 p.m.

If you want to buy shares, your order will be fulfilled after the day's NAV has been calculated. If you want to invest $1,000, for example, you can place your order any time after the previous day's close, but you won't know how much you'll pay per share until the day's NAV is posted. If the day's NAV is $50, then your $1,000 investment will buy 20 shares.

Mutual funds typically allow investors to purchase fractional shares. If the NAV in the above example is $51, your $1,000 will buy 19.6 shares.

About Fees

Mutual funds carry annual expense ratios equal to a percentage of your investment, and a number of other fees may be charged.

Some mutual funds charge load fees, which are essentially commission charges. These fees do not go to the fund; they compensate brokers who sell shares in the fund to investors.

Not all mutual funds carry upfront load fees, however. Instead of a traditional load fee, some funds charge back-end load fees if you redeem your shares before a certain number of years have elapsed. This is sometimes called a contingent deferred sales charge (CDSC).

Mutual funds may also charge purchase fees (at the time of investment) or redemption fees (when you sell shares back to the fund), which go to defray costs incurred by the fund.

Most funds also charge 12b-1 fees, which go towards marketing and advertising the fund. Many funds offer different classes of shares, called A, B or C shares, which differ in their fee and expense structures.

Trade and Settlement Dates

The date when you place your order to purchase or sell shares is called the trade date. However, the transaction is not finalized, or settled, until a couple of days have elapsed.

The Securities and Exchange Commission (SEC) requires mutual fund transactions to settle within two business days of the trade date. If you place an order to buy shares on a Friday, for example, the fund is required to settle your order by Tuesday, since trades cannot be settled over the weekend.

Ex-Dividend and Report Dates

If you are investing in a mutual fund that pays dividends but you want to limit your tax liability, find out when shareholders are eligible for dividend payments. Any dividend distributions you receive increase your taxable income for the year, so if generating dividend income is not your primary goal, don't buy shares in a fund that is about to issue a dividend distribution.

The ex-dividend date is the last date when new shareholders can be eligible for an upcoming dividend. Because of the settlement period, the ex-dividend date is typically three days prior to the report date, which is the day that the fund reviews its list of shareholders who will receive the distribution.

If you want to receive an upcoming dividend payment, purchase shares prior to the ex-dividend date to ensure your name is listed as a shareholder on the date of record.

On the other hand, if you want to avoid the tax impact of dividend distribution, delay your purchase until after the date of record.

Selling Mutual Fund Shares

Just like your original purchase, you sell mutual fund shares directly through the fund company or through an authorized broker.

The amount that you receive will be equal to the number of shares redeemed multiplied by the current NAV, minus any fees or charges due.

Depending on how long you have held your investment, you may be subject to a CDSC sales charge. If you want to sell your shares very soon after purchasing them, you may get slapped with additional fees for early redemption.

Early Redemption Rules

Stocks and ETFs can be short-term investments, but mutual funds are designed to be long-term investments.

Constant trading of mutual fund shares would have serious implications for the fund's remaining shareholders. When you redeem your mutual fund shares, the fund often has to liquidate assets to cover the redemption, since mutual funds don't keep much cash on hand.

Any time a fund sells an asset at a profit, it triggers a capital gains distribution to all shareholders. That increases their taxable incomes for the year and reduces the value of the fund's portfolio.

This kind of frequent trading activity also causes a fund's administrative and operational costs to rise, increasing its expense ratio.

Not surprisingly, fund companies discourage frequent trading.

To discourage excessive trading and protect the interests of long-term investors, mutual funds keep a close eye on shareholders who sell shares within 30 days of purchase – called round-trip trading – or try to time the market to profit from short-term changes in a fund's NAV.

Mutual funds may charge early redemption fees, or they may bar shareholders who employ this tactic frequently from making trades for a certain number of days.