Up-to-the-Minute Financial Commentary about Money, Investing, and How It Affects the Average Investor

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Today's Commentary: 04.23.04
How Mutual Fund Investors Lose

Using mutual funds for your retirement plan have become de rigueur for investors. They not only allow broad participation in the markets but they allow the investor some peace-of-mind that their money is safe in the hands of money managers who have their best interest at heart. Or perhaps not.

It is unfortunate that regulation of this industry, which has over $7 trillion under management would not be more open to self regulation. It doesn't take a business degree to understand that straightforward honesty and transparency would be the one thing that investors could wrap themselves around. If only it were that simple.

Mutual funds, as many of you already know, pool investor capital and use the money to invest in broad based indexes, growth and value, or more specifically in sectors. This has allowed investors to reap the benefits of compounding, dollar cost averaging, and until now, the knowledge that their investment advocate was hard at work making sure that their money was safe and fully invested.

If it were that simple, there would be no need for the Securities and Exchange Commission to step in and propose that trading stop immediately at 4pm. To those who may have been suffering from that previously aforementioned and naive understanding of the industry, the suggestion that funds close at 4pm sharp may come as a surprise. Many folks believe that this close, the time when all of the assets of the fund are tallied to reach a Net Asset Value for the fund, is already a hard fact. But it is not.

Traders who understand the volatility of the markets may be able to get a better price exactly at the 4pm close. This is costing long term investors an estimated 1% of current equity assets under management. How will a hard close help? Let's first take a look at how it hurts.

An investor who purchases shares in a mutual fund at the close of trading creates a problem not only for the manager but for the long term investor as well. The money the fund received at 4pm will not be used to purchase stocks until the following day and usually at the higher price of the markets next day open. Falling markets might find redemptions to be the problem as shares are sold at a higher price than the next days open.

Some companies have voluntarily closed their funds at 2:30pm allowing their managers to invest the cash on hand in the markets without these anomalies coming into play. But don't expect the industry to adopt these rules without regulation. And that is a shame.

Contemporary pricing benefits more shareholders in the long run. SEC chairman William Donaldson testified before the Senate Banking Committee recently that the agency is looking at the effects of a hard cut off in trading. With many competing interest at play here, the proposal, he said, "wouldn't disadvantage certain investors and wouldn't disadvantage competition in the marketplace".

That doesn't sound like the chief regulator wants to step in and tell the industry to stop. He may believe that this kind of regulation would impact liquidity and the ease of investment. Any sluggishness by the agency in moving toward a hard trading close for the industry would definitely not be seen as an effort to protect long term investors. Perhaps they are hoping that long term investors just won't notice.

The Blue Money Report
Financial Commentary covering a wide range of topics concerning money, investing, and how it effects the average investor and their financial health.

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