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The news of scandal has recently rocked
the $7 trillion mutual fund industry. If you own a mutual fund, are
wondering how this might affect you and what action you should take,
read on.
Many of the recent charges relate to a practice known as late
trading. Mutual fund orders have to be placed by 4 p.m. Eastern time
in order to receive that day’s closing price. If an order is
received after the cut-off, it can’t be processed until the
following day.
But with late trading, selected orders received after the cut-off
are still given same-day status. Some mutual fund companies allowed
a select few to do this and then went to great lengths to cover up
these trades. This is clearly illegal and those involved should be
severely punished.
Market timing is another practice being scrutinized. Traders buy and
sell mutual fund shares based on small changes in the prices of a
fund’s underlying stocks that aren’t currently reflected in the
fund’s share price. This is most often done with international stock
mutual funds, because of the delay in the close of overseas markets
and those in the U.S. Market timing itself is not illegal. But some
mutual funds stated in their prospectus that they did not allow such
trading, but secretly allowed it anyway for certain investors.
The effect of both of these practices is that they allowed a
privileged few to profit while in effect lowering the overall
returns for the large number of smaller, longer term investors. The
willful deception of shareholders by the fund management is
inexcusable.
It’s important to keep these charges in perspective. First, the
underlying value of the stocks in these mutual funds has not been
affected. This isn’t like Enron where you could see your investment
drop 80% simply because of the scandal. Second, the market timing
charges are mostly limited to international funds. Third, so far
only a few fund companies are affected. And last, mutual funds in
general still remain an excellent investment vehicle.
What should you do if you are in one of the mutual funds named in
this scandal? You might want to consider getting out of that fund
and that fund company altogether. But getting out might be difficult
if you face a stiff penalty or recently paid a big commission when
you purchased it.
In this case, you’d have to weigh the cost of liquidation against
the level of your concern. If moving out of the fund family
altogether proves too costly, you can at least move ‘sideways’ into
a less-affected fund in the same fund family.
If you are trapped in a fund family because of commissions or
penalties, you should probably find a different advisor. My clients
don’t have to pay big commissions or face stiff surrender penalties
on their investments and neither should you! It is completely
unnecessary and it severely limits your ability to quickly make
changes when needed.
You might also consider alternatives to investing in mutual funds.
For instance, Exchange Traded Funds (ETFs) provide the
diversification of a mutual fund but are actively traded like a
stock, which means they can be bought or sold any time during the
day. ETFs are designed to mimic an underlying index and since they
are not actively managed, they have very low internal fees.
Several things are certain about the current mutual fund scandal.
More affected companies will be named in the weeks and months ahead.
Criminal and civil charges will continue to be filed. Class action
suits are sure to follow. New regulations will be discussed to keep
such illegal activities from reoccurring.
The jury is still out on how all of this will affect you. Hopefully
some positive reforms will result, but regulators have a tendency to
overreact and create solutions that in the end do more harm than
good. Stay informed, keep an eye on your funds, and be prepared to
make adjustments so you can stay on track to meet your goals.
If you have questions or are concerned about the funds you are
invested in and would like my opinion on your specific situation,
free of charge, let me know. It’s your money and you need to make
sure it is protected.
Mr. Voudrie is a Certified Financial Planner and President of Legacy
Planning Group, Inc., a Private Wealth Management Firm in Johnson
City, TN. He can be reached toll-free at 1-877-827-1463 or at jeff@guardingyourwealth.com
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