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Cashing out?

Globe and Mail Update

Leave it to the mutual fund business to find a way to pocket some cash when investors sell in a panic.

Billions of dollars have been taken out of mutual funds in the past three months by investors who couldn't take the pain of a plunging stock market any longer. Fund companies are hurting because they're losing assets on which they can charge fees, but don't feel too badly for them.

In some cases, these companies are charging a redemption fee as high as 6 per cent on money pulled from a fund. What's worse is that some companies charge the redemption fee against your original investment, not the much-depleted current value.

Thanks go to the Investors-Aid Co-operative of Canada for pointing this out. “I think it's worthwhile preparing people,” said Garth Rustand, the co-operative's executive director. “Most don't know that if they lose their job and they're trying to access cash, they may have to pay a redemption cost on the original cost of their investment, rather than the current value.”

The co-operative was formed in May and just recently introduced its website at investors-aid.coop. It's an educational organization that invites people to join up to take advantage of online tools and tutorials. No products or actual advice are offered.

“We're a consumer protection co-operative,” said Mr. Rustand, who spent 14 years as a broker. “Our focus is lowering people's costs and protecting them from products that aren't very good.”

Mutual funds with redemption fees make the list of investments that are not very good. Imagine having to pass through a toll booth before selling your hard-hit funds and you'll get the idea.

You run the risk of paying redemption fees if you bought your mutual funds with a deferred sales charge, usually referred to as the DSC option. The appeal of DSC is that you don't pay a cent in upfront commissions to your investment dealer to buy a fund. Redemption fees apply if you sell within six or seven years of buying, and they typically start at 6 per cent in the first year and then gradually fall to zero.

The financial research firm Investor Economics says funds sold with a DSC account for about 54 per cent of assets in so-called load funds, which are sold with either an upfront purchase fee (it's often waived) or a deferred sales charge.

Load funds are different from no-load funds, which charge nothing to buy or sell.

A quick check of the prospectuses issued by some major load mutual fund companies shows there are two distinct ways of charging redemption fees. Mackenzie, Investors Group and Dynamic apply their fees against the amount you're selling. AGF, CI, Fidelity and Invesco Trimark apply the fee on your original investment.

“The deferred sales charge is based on the value of the securities when you bought them and is deducted from the value of the securities you sell,” AGF says in its prospectus.

Let's say you invested $10,000 at the beginning of the year in AGF Canadian Large Cap Dividend-Classic and then watched its value fall 36.5 per cent up to Dec. 2. This is not an egregious decline when compared with the 40-per-cent plunge in the S&P/TSX composite index over the same period, but let's say you're stressed about losing more of your capital and you want out.

According to the AGF prospectus, the redemption fee would be 5.5 per cent applied against $10,000, or $550. Problem is, your $10,000 investment is now worth about $6,350. Thus your redemption fee represents a hit of 8.7 per cent on your investment as it stands now.

Mutual fund companies disclose all their fees in their prospectuses, but Mr. Rustand complained that it's unclear in some cases if the fees are charged on the original investment or current value.

“The information is certainly not mentioned in a prominent way, like it should be,” he said.

Two things to keep in mind if you're itching to sell a fund and face redemption charges: You can usually redeem 10 per cent of your holdings in a DSC fund every year without fees, and you can switch into other funds in the same family without a fee in most cases.

Oh, and when buying funds the next time, just say no to the DSC option and ask about the alternatives.

A growing trend among advisers is to sell front-load funds with the sales commission either eliminated (this is called zero load) or held to 1 per cent.

A record $8.4-billion was pulled out of mutual funds in October and, while things calmed down somewhat last month, the industry still reported net redemptions of about $1-billion. Looking for a reason to hang on instead of selling and locking in your losses? Visions of your fund company slapping a redemption fee on the remnants of your portfolio should do the trick.

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