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New Rule Could Negatively Affect 401(k) Investors
By JLP | October 16, 2007
They claim that the new SEC rule was designed to deter day trading in mutual funds. I think it was designed to be a cash cow for the mutual fund companies.
Here’s the deal:
According to this WSJ article, effective today, a new SEC rule will require brokerage firms, retirement-plan administrators and other intermediaries who hold fund shares on behalf of individual investors to share those individuals’ trading data with mutual-fund companies upon request. This data will then be “scrutinized” by the fund firms looking for suspicious day-trading activity. Offenders will then either be slapped with redemption fees (usually 2%) or locked out of the mutual fund.
On the surface this sounds like a good thing. However, routine rebalancing by buy-and-hold investors could trigger redemption fees. That’s not a good thing.
There’s no doubt that rapidly trading in and out of mutual funds is expensive and hurts long-term buy-and-hold investors. However, it seems like their answer to this problem is no better than the problem itself.
One thing the article mentioned was that some investors were rebalancing quarterly. Why? I think that’s too often. In my opinion rebalancing should be done once per year or whenever the allocation moves 5% or more from its target. Quarterly seems like busy work.
What can you do if you are slapped with a redemption fee?
Talk to the mutual fund company or the 401(k) administrator to see if you can get the fee dropped. If you can prove that you aren’t a frequent trader, the mutual fund company will most likely drop the fee. Another thing you can do as a preventive measure is to read your plan documents to find out about redemption fees.
Topics: 401(k), Investing, Retirement Planning | 10 Comments »
October 16th, 2007 at 3:14 pm
There is quite a bit of difference between a day trader and someone who rebalances a portfolio every quarter or year. Surely whoever is looking at these transactions can tell the difference.
October 16th, 2007 at 3:50 pm
Sam,
One would think. However, that’s not what the WSJ article said. It’s as if you are guilty unless you prove yourself innocent.
October 16th, 2007 at 5:04 pm
Im sure they are going to have some piece of software monitoring the trades, rather than an actual person. If they do this, it will be set up with a limit on trades during a given time frame (say 10 changes in 1 year) or something like that. Now with a proper check in place, this system would then send a report of all people who have surpassed that limit, notify a department who will be in charge of this rule, and then a person could review that activity and make a proper decisions to see if it is a day trader or just some guy balancing his investments.
The problem will come when the department handling these gets too much of a workload and the people just start rubber stamping the lock outs and fees.
October 16th, 2007 at 6:10 pm
This might be an SEC rule, but it’s been in place at Fidelity 401ks for a while. Yes, this includes rebalancing when things get really out of wack – like the big runup, then rundown in the market recently.
October 16th, 2007 at 10:17 pm
What about when my company removes a fund and then I have to fix my portfolio? Eh, rules.
October 16th, 2007 at 10:45 pm
Well I’m surely no expert. Nor is this a simple issue. But if I had to guess, the rule was designed to protect the fund managers themselves. Not the investors, so with that in mind. Who loses? Surely there is little to be said about the changes brought about in the market by these so called day traders masquerading as 401K participants. The bottom line might be this. If the fund managers were worried about the fund members return on investment and less worried about their year end bonuses we might all be better off. Well not all, surely the fund managers couldn’t count on those million dollar plus pay outs. It’s time they start protecting the people that pay their salaries. Most would be very happy to earn a fraction of what they earn in a month, yearly. Has anyone seen what these fund managers are earning these days. It’s no secret they earn 100 times the normal wage of the average person. Guess who that average person is, the one they claim might be using his or her 401K as a day trading account. I’d like to see the figures and model they used for that one! Does anyone really believe these people are worth what they get paid? Recently a report was released that revealed the average guy on the streets with little to no experience in stock trading was more likely to achieve a better return on investment then those so called brokers we all tend to trust with our investments. This should tell you something… It tells me their grossly over paid as it is without allowing them to earn an extra 100K on the fees end of the deal too. Were does it stop? In closing allow me to pose one final question. Isn’t the goal of own stock to earn money? So if one sees an opportunity they must reframe from taking this into account because it might look like they are trying to make money! It’s crazy and under reasonable conditions completely unenforceable to start with. If the SEC really wants to do something positive for the market, start watching the guys earning $ 400,000,000.00 a year. Surely there’s more to learn there about what’s wrong with the market and why it’s almost impossible for the little guy to make money these days.
October 17th, 2007 at 11:56 am
anyone who is impacted by this new rule has an “investment” philosophy that needs adjusting.
October 17th, 2007 at 12:34 pm
Don’t they have pre-defined limits for it? In Canada lots of funds have a rule that if you sell units within 90 days of purchasing them you can be charged a 2% trading fee – if you’re selling your whole investment in a fund every 3 months that’s more than rebalancing, and if there’s any doubt you know the rule.
This seems to help everyone invested in the fund because it stops people from buying and selling every day while letting others carry the cost but it’s still a resonable timeframe that allows you to balance your portfolio when needed.
October 20th, 2007 at 1:24 pm
Rebalancing on a quarterly basis is a good thing, here is why: assume that you have multiple asset classes all with a certain expected average return, however in any given quarter (or day for that matter) they can generate more or less than that expected average return. You know that any short term fluctuations in price will resolve themselves once each asset class reverts to its mean return, however, if you rebalance quarterly (or daily for that matter), you automatically sell the assets that have appreciated more than expected and buy more of those that underperformed. When the assets regress to the mean expected return, your actual return will be higher than it would have been without rebalancing.
The catch? Trading costs. If there is a way for you to rebalance daily, automatically without wiping out any gains through trading costs, that is a very good idea.
October 21st, 2007 at 8:19 am
JMHO – When you are expecting a choppy market for an extended period of time…you attempt to enforce actions that will limit your costs. All increase in cost with no real upside expectation (sideways to lower ‘grind’) for a bull fund will hurt profit and performance…so the public will be forced to pay the piper. It certainly won’t be the fund…
Bottomline – in an environment where outflows are more likely than inflows…hedge against the outflow or move into another long term investment that thrives in a different market. Don’t rebalance, fully review.