Schwab Will Extend Fund-Holding Period

Some mutual fund investors will find it more expensive to quickly trade in and out of funds, thanks to 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--announced plans to extend the number of days investors will have to stay in some mutual funds to avoid getting slapped with redemption fees incurred when selling out of the funds.

Industry observers fear that other fund companies will follow Schwab’s lead in an effort to discourage rapid trading, which raises funds’ and brokers’ costs and hurts funds’ 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 additional charges.

Schwab officials deny the plan was a direct reaction to the recent volatility in the stock market.

“It’s actually been in the works for more than a year,” Schwab spokesman Glen Mathison said.

Starting 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, the company said it will place a cap on its transaction fees, which work on a sliding scale based on the size of the trade.

The extended holding period affects about 1,500 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 mutual fund marketing. “These policy changes help offset those extra costs, and we hope they will discourage frequent trading.”

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

Paul Merriman, editor of the FundAdvice.com newsletter in Seattle, noted that up until last month, the industry didn’t have to think about these issues.

But in August, a net $2.7 billion was pulled from mutual funds sold through Schwab. Industrywide, an estimated $5.4 billion was pulled from stock mutual funds, according to the Santa Rosa research firm Trimtabs.com. It marked the first month of net redemptions from stock funds since the bear market of 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,” Markese said. “Six months is going to deter short-term traders, but it might also affect people’s routine decision-making.”