Redemption
You've learned how mutual fund shares are purchased and priced. Now let's cover how investors get their money back: the redemption process, back-end charges, withdrawal plans, and the Class B conversion privilege.
Redemption Price
Open-end fund shares are redeemed at Net Asset Value (NAV) (minus any applicable CDSC):
- The fund must pay redemption proceeds within 7 calendar days of receiving the redemption request
- The fund may suspend redemptions only in extraordinary circumstances:
- SEC order
- Exchange closure (other than weekends/holidays)
- Emergency conditions
Think of it this way: Unlike closed-end funds where you sell on the open market, mutual fund redemptions go directly back to the fund at NAV. The fund itself is your buyer.
Exam Tip: Gotchas
- Redemption proceeds must be paid within 7 calendar days (not business days). The exam tests this distinction frequently.
Contingent Deferred Sales Charge (CDSC)
The CDSC is a back-end load that declines over time:
- Typical Class B CDSC schedule: 5% in year 1, declining to 0% by year 6-8
- Typical Class C CDSC: 1% if redeemed within 1 year, then 0%
CDSC calculation rules:
- Calculated on the lesser of the original purchase price or current NAV at redemption
- First In, First Out (FIFO) method is used to determine which shares are being redeemed (oldest shares first)
- Shares acquired through reinvestment of dividends and capital gains are typically exempt from CDSC
Think of it this way: You bought shares at $20. They're now worth $25. The CDSC is calculated on $20 (the lesser amount). This protects investors from paying a sales charge on appreciation they earned.
Exam Tip: Gotchas
- CDSC is calculated on the lesser of purchase price or current NAV. Never the higher amount.
- FIFO is used for CDSC calculations (oldest shares redeemed first).
- Reinvested dividends are typically exempt from CDSC.
Systematic Withdrawal Plans
Systematic withdrawal plans allow shareholders to receive regular payments from their accounts:
| Plan Type | How It Works |
|---|---|
| Fixed-dollar | Same dollar amount each period |
| Fixed-share | Same number of shares redeemed each period |
| Fixed-percentage | Same percentage of account value each period |
| Fixed-time | Entire account distributed over a set number of periods |
Suitability rule: Simultaneous purchase of fund shares and systematic withdrawal is generally not suitable. The investor would be paying sales charges while withdrawing, which is considered churning.
Exam Tip: Gotchas
- Simultaneous purchases and systematic withdrawals = unsuitable. Paying sales charges while withdrawing is churning.
Conversion Privilege (Class B to Class A)
- Class B shares automatically convert to Class A shares after a specified period (typically 6-8 years)
- After conversion, the shareholder pays the lower Class A 12b-1 fee (0.25% vs. 1.00%)
- The conversion is not a taxable event
Think of it this way: Class B shares have higher ongoing 12b-1 fees. The automatic conversion ensures that long-term Class B holders eventually get the benefit of lower ongoing expenses, similar to what Class A holders pay from day one.
Exam Tip: Gotchas
- Class B to Class A conversion is NOT a taxable event. The shares change class, but no sale occurs.