Trading mutual funds is possible, but is it worth the time and effort? We’re going to briefly discuss what mutual funds are, and then we’ll discuss what it means to trade them, and we’ll draw a final conclusion as to whether or not mutual fund trading is going to be a worthy pursuit.
Mutual funds are an open-ended fund that have been used for the past couple of decades as a sort of safe-haven investment vehicle. They don’t provide the most outstanding returns, but they are considered reasonably safe, though the level of risk varies from fund to fund. You can choose to go with a passively maintained fund, or one that is actively traded. Mutual funds are not traded on an open exchange (NYSE, NASDAQ, AMEX, etc) which is part of what differentiates them from Exchange Traded Funds (ETFs). The SEC defines Mutual Funds as:
“… a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, or other securities. Legally known as an “open-end company,” a mutual fund is one of three basic types of investment company.”
The inability to purchase these funds on an exchange is then listed as their first defining characteristic. When you invest in a mutual fund, you are purchasing shares of the fund itself, and not directly purchasing the stocks, bonds, or other instruments that the mutual fund owns. The cost of each share is determined by the Net Asset Value (NAV) and these shares can only be purchased directly from the fund itself, or a broker acting in the name of the fund. The Net Asset Value is based on the closing price of all assets held within the fund less any liabilities associated with the fund.
Fees are imposed in a few different ways, but if you’re interested in trading mutual funds, you’re going to be looking at no-load funds. Front-load fees are applied when you purchase some mutual funds, and is a percentage of your invested capital that goes directly to the mutual fund, rather than directly to the purchase of shares in the fund. This is simply lost cash. There are also different back-load types where you are charged for selling your shares (a percentage often calculated depending on the amount of time you’ve held the shares). Given that you’re looking to trade mutual funds, all of these fees are undesirable (and are often undesirable when investing long-term as well). This is why you’re looking for no-load mutual funds.
Trading mutual funds can only be done at the end of the trading day after the mutual funds NAV has been calculated. An order to buy or sell has to be entered before this value is calculated. An order to buy or sell after the NAV has been calculated will be carried out the next day after the market closes, and the NAV is recalculated.
Side note: Late trading mutual funds is when a mutual fund allows certain investors to buy or sell based on that day’s NAV after it’s been calculated, and they’ve researched what other markets were doing, and observe how news items (like the many earnings announcements that are made after-hours) impacted the markets. This research allowed them to reasonably assume where the market would open the next day. This gave such investors and unfair edge, while piling on fund-related fees, that all investors in the fund had to pay for. Mutual fund late trading is illegal, and the SEC cracked down on this practice in the early 2000′s. This is not to be confused with after-hours trading, which is legal and unrelated.
All right, so back to trading in mutual funds. Because mutual funds are only priced once a day, traders lack ability to see any real-time data. The only way to really have an idea of where a mutual fund might close is to study the mutual funds holdings portfolio. This level of research is something you’d also have to do if you were simply trading the stocks, or other instruments themselves. Even if you could predict swings in the prices of the mutual funds portfolio, once again, you’re only able to trade the funds (essentially) once per day at the closing price for that day. These funds are infinitely liquid though; if you want to sell your shares, the fund has to buy them, and you can’t be stuck in a position. This is really the only positive for trading mutual funds.
It’s our belief that it’s unreasonable to try to trade mutual funds using market timing. There are too many better instruments and better markets to spend your time and money trading in. You might find mutual funds to be a great investment, but trading and investing are two different things. The potential fees, and lack of visiblity and flexibility make them too difficult to deal with for trading purposes. ETFs are similar to mutual funds in their diversity of holdings (sometimes) but they allow you the trading flexibility of a stock. If you’re interested in trading mutual funds, we suggest looking into trading ETFs, like a biotech ETF, instead.