Schwab Will Tighten Rules on Fund Trading

Some mutual fund investors will find it more expensive to quickly trade in and out of funds, in the wake of a change announced Friday by Charles Schwab & Co.

The nation’s largest discount broker--which operates one of the largest “fund supermarkets” that allow investors to buy and sell funds offered by different fund families--said it will extend the number of days investors must stay in some funds to avoid getting slapped with redemption fees incurred when selling out.

Industry observers fear that other fund companies will follow Schwab’s lead in an effort to discourage rapid trading, which can raise funds’ costs and hurt performance.

“We saw mass redemptions in August,” said Larry Chin, senior editor of the No-Load Fund Analyst newsletter in Orinda, Calif., “so I wouldn’t be surprised if others did something too.”

Observers also fear that these tougher rules might unintentionally discourage long-term investors from making ordinary and necessary adjustments to their portfolios, for fear of incurring charges.

Schwab officials deny the plan was a direct reaction to recent market volatility. “It’s actually been in the works for more than a year,” spokesman Glen Mathison said.

After Nov. 23, investors who buy funds without front-end transaction fees, or loads, through Schwab’s popular OneSource program will have to stay in those funds for more than 180 days to avoid redemption fees.

Currently, individuals can sell out of a OneSource fund after 90 days without penalty. The holding period for institutional clients, such as financial advisors, has been extended too, from 60 days to 90.

At the same time, Schwab said it will cap all of its fund transaction fees, which now work on a sliding scale based on trade size.

The extended holding period affects about 1,500 no-load funds that are managed by 200 mutual fund companies and are sold through Schwab’s OneSource plan.

“Frequent trading of mutual funds can have adverse effects on fund shareholders and also has significant administrative costs for Schwab,” said Jeff Lyons, Schwab’s senior vice president for fund marketing. “These policy changes help offset those extra costs, and we hope they will discourage frequent trading.”

Most stock funds tend to be “fully invested,” meaning they invest all the money they get from shareholders into the market. If investors stop putting money into these funds--or if they pull money out--fund managers can be forced to sell stocks to meet those redemptions. And that can hurt the fund’s overall performance.

In August, a net $2.7 billion was pulled from funds sold via Schwab. Industrywide, an estimated $5.4 billion was pulled from stock funds, according to research firm Trimtabs.com. It marked the first month of net redemptions since 1990.

John Markese, president of the American Assn. of Individual Investors in Chicago, said he believes redemption fees won’t stand in the way of investors fleeing a fund should the market tank. But he expressed some concern about the length of time that Schwab will be extending its holding period.

“Six months is pushing the unreasonable level,” he said. “Six months is going to deter short-term traders, but it might also affect people’s routine decision-making.”

Investors who sell out of a OneSource fund early now are charged a minimum fee of $39 and are subject to the same sliding fee schedule as are holders of non-One-Source funds sold by Schwab.

Starting Nov. 23, as it extends the OneSource holding period, Schwab will cap all transaction fees at $149 per fund trade ($119.20 for trades over the Internet). Starting Feb. 20, the fee for short-term OneSource redemptions will be 0.75% of the trade value, with a cap of $299 for broker-assisted trades and $199 for Internet trades.