What is a ‘Redemption’
A redemption is the return of an investor’s principal in a fixed-income security, such as a preferred stock or bond, or the sale of units in a mutual fund. Fixed-income securities are redeemed at par value on the maturity date, and called bonds are redeemed at a premium price above par. On the other hand, mutual fund investors redeem mutual funds shares, and the some mutual funds have minimum holding periods and back-end sales charges.
BREAKING DOWN ‘Redemption’
The redemption of an investment may generate a capital gain or loss, and the taxation of capital gains is reduced by capital losses recognized in the same year. Capital gains and losses are recognized on both fixed-income investments and mutual fund shares.
Examples of Capital Gains and Losses
To compute the capital gain or loss on redemption, the investor needs to know the cost basis. Bonds can be purchased at a price other than the par amount (face amount) of the bond. Assume, for example, that an investor buys a $1,000 par value corporate bond at a discounted price of $900, and receives $1,000 par value when the bond is redeemed at maturity. The investor has a $100 capital gain for the year, and the tax liability for the gain is offset by capital losses. If the same investor purchases a $1,000 par value corporate bond for $1,050 and the bond is redeemed for $1,000 at maturity, the $50 capital loss reduces the $100 capital gain for tax purposes. Mutual fund gains and losses are included in the same capital gain calculation.
How Mutual Fund Redemptions Work
The redemption of fund shares from a mutual fund company must occur within seven days of receiving a request for redemption from the investor. Some mutual funds may have redemption fees attached, in the place of a back-end load. A back-end load is a sales charge, and the charge is a percentage of the fund’s value, which declines over time. If the investor holds the fund shares for a longer amount of time, the back-end load charged when the shares are redeemed is smaller. Investments in mutual funds> are designed for individuals who buy and hold fund shares for the long term, and selling fund shares after a short period of time results in higher costs to the investor. The investor pays sales charges and annual fees for professional portfolio management and the fund’s accounting and legal costs.
Because mutual funds are priced only once per day, investors wishing to redeem their money must place the order before the market’s close, or the time set by the mutual fund. Money is redeemed at the fund’s net asset value (NAV) for the day, which is calculated as the sum of the value of the assets of a fund less its liabilities. Once the sale goes through, clients typically receive their funds including any gains via check or direct deposit to their bank account.