Can You Day Trade Mutual Funds?

Day trading is commonly considered a high-risk, high-reward strategy that involves buying and selling financial instruments within a single trading day.

Mutual funds, conversely, are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities.

Key Takeaways – Can You Day Trade Mutual Funds?

• Mutual funds can’t be day traded due to once-daily pricing and execution.
  • Unlike stocks or ETFs, mutual fund orders are processed at the end-of-day NAV, eliminating intraday profit opportunities.
• Frequent mutual fund trading is actively discouraged through redemption fees, trading restrictions, and minimum holding periods imposed by fund companies to protect long-term investors.
• For short-term trading, consider ETFs, index futures, or individual stocks instead.
  • These offer intraday liquidity and price movements that mutual funds lack.
• Mutual funds are better suited for long-term investing strategies.
  • These offer professional management, diversification, and the ability to dollar-cost average with lower stress than active trading.

The Nature of Mutual Funds

Mutual funds are designed for longer-term investing.

They’re managed by professional fund managers who make investment decisions on behalf of the fund’s investors.

Unlike stocks, mutual funds are priced and traded once per day, after the market closes.

Day traders, on the other hand, try to capitalize on small price movements in highly liquid stocks, currencies, or other assets.

They often use leverage to amplify potential gains, but this also increases their risk.

Success in day trading requires in-depth knowledge of their markets, quick decision-making skills, and the ability to handle stress.

Can You Day Trade Mutual Funds?

The short answer is no, you can’t day trade mutual funds in the traditional sense.

Several factors make day trading mutual funds impractical or impossible:

Once-a-Day Pricing

Mutual funds are priced at the end of each trading day.

This Net Asset Value (NAV) is calculated based on the closing prices of all securities in the fund’s portfolio.

You can’t buy or sell mutual funds at real-time prices throughout the day like you can with stocks.

Order Execution Timing

When you place an order to buy or sell a mutual fund, it’s executed at the next available NAV.

If you place an order during market hours, it will be executed at the NAV calculated after the market closes that day.

This eliminates the possibility of profiting from intraday price movements.

Redemption Fees and Restrictions

Many mutual funds impose redemption fees on shares held for short periods.

These fees, typically 1-2% of the redemption amount, are designed to discourage short-term trading and protect long-term investors from associated costs.

Alternatives to Day Trading Mutual Funds

While you can’t day trade mutual funds, there are several alternatives that might suit your goals better or more feasibly:

Exchange-Traded Funds (ETFs)

ETFs are similar to mutual funds in that they represent a basket of securities, but they trade on exchanges like stocks.

You can buy and sell ETFs throughout the trading day at market prices.

This makes them suitable for day trading strategies.

You can also trade a variety of different things through them – basic indices, sectors, alternative assets (bonds, commodities), and more customized strategies (e.g., covered call writing).

Index Futures

For those interested in trading broad market movements, index futures offer a way to speculate on the direction of major market indices.

These are highly liquid and can be traded with significant leverage.

With futures, the leverage is built into them directly and they’re generally not a great fit for long-term trading or investing because the forward price is built into them directly.

For example, stock and gold futures trade higher relative to the spot price to reflect future expectations.

Individual Stocks

Day trading individual stocks remains a popular choice for many traders.

With thousands of stocks to choose from, there’s no shortage of opportunities for those with the skills and risk tolerance to engage in this high-stakes activity.

The Risks of Frequent Trading in Mutual Funds

Even if you can’t day trade mutual funds, some attempt to engage in frequent trading.

This practice comes with significant risks and drawbacks:

Market Timing Risks

Attempting to time the market by frequently buying and selling mutual funds is notoriously difficult.

Even professional fund managers struggle to consistently outperform the market through timing strategies.

Higher Costs

Frequent trading incurs higher transaction costs, which can eat into your returns.

These costs include potential redemption fees, as well as buy and sell spreads.

Mutual fund managers impose these to prevent excess volatility in outflows, which can disrupt their strategy.

Tax Implications

In taxable accounts, frequent trading can lead to higher short-term capital gains taxes.

These are typically taxed at a higher rate than long-term capital gains.

Mutual Fund Policies to Prevent Frequent Trading

To protect long-term investors, many mutual fund companies have implemented policies to discourage frequent trading:

Trading Restrictions

Some funds limit the number of trades an investor can make within a specified period.

For example, a fund might allow only four trades per year.

Minimum Holding Periods

Funds may require investors to hold their shares for a minimum period, often 30 to 90 days, before selling without incurring a fee.

Fair Value Pricing

To prevent arbitrage opportunities in international funds, many companies use fair value pricing.

This involves adjusting the prices of foreign securities to reflect events that occur after the close of foreign markets but before the fund’s NAV is calculated.

The Case for Long-Term Mutual Fund Investing

The allure of quick profits from day trading is strong for those who have the risk tolerance and time, but long-term investing in mutual funds offers several advantages.

But before we get into these, one important point:

Not One or the Other

When choosing what to do, it doesn’t have to be one thing or the other.

You can tactically trade part of your savings and have the bulk of it in a more passive, strategic approach.

Some traders have their core allocation and make tactical decisions within that structure.

For example, a trader might want 40% of their portfolio in stocks but give themselves liberty on which to choose in light of that.

With that said, mutual funds offer:

Professional Management

Mutual funds are managed by experienced professionals who have access to extensive research and resources.

This can be good for those who lack the time or expertise to manage their own portfolios.

Diversification

Mutual funds typically hold a diverse range of securities, which can help spread risk.

This diversification would be difficult and expensive for individual investors to replicate on their own.

Dollar-Cost Averaging

Regular investments in mutual funds allow you to take advantage of dollar-cost averaging.

This strategy involves investing a fixed amount at regular intervals, regardless of market conditions.

Over time, this can help reduce the impact of market volatility on your overall investment.

Lower Stress and Time Commitment

Long-term mutual fund investing requires much less day-to-day attention than active trading strategies.

This can lead to lower stress levels and free up time for other pursuits.

Choosing the Right Mutual Funds for Your Goals

If you’ve decided that long-term mutual fund investing aligns better with your financial objectives than day trading, consider these factors when selecting funds:

Investment Objective

Different funds have different goals.

Some aim for capital appreciation, others for income generation, and some for a balance of both.

Choose funds that align with your investment objectives.

Risk Tolerance

Assess your risk tolerance honestly.

Aggressive growth funds might offer higher potential returns but come with greater volatility.

Conservative funds might provide more stability but lower growth potential.

Fees and Expenses

Pay attention to a fund’s expense ratio.

This ongoing fee can significantly impact your returns over time.

Index funds and some ETFs typically have lower expense ratios than actively managed funds.

If a fund has an expense ratio of 0.65%, that means for every $10,000 invested you’d incur expenses of $65 per year.

Performance History

Past performance doesn’t guarantee future results, but it’s worth examining how a fund has performed in different market environments.

My personal preference is a fund that has a track record to before 2008 and even ideally before 2000 so you can understand how it did during stress periods.

Conclusion

Day trading mutual funds isn’t possible, and frequent trading of mutual funds is generally discouraged, but there’s a middle ground between ultra-short-term trading and completely passive investing.

Some traders successfully use a combination of longer-term mutual fund holdings for stability and diversification, while allocating a portion of their portfolio to more active strategies using ETFs or individual stocks.

The key is to understand your financial goals, risk tolerance, and the amount of time you’re willing to devote to managing your portfolio.

For many, a balanced approach that includes mutual funds as part of a diversified, long-term strategy may provide the best path to achieving their financial objectives.

It’s a personal journey, and what works best will vary from one individual to another.