When Fund Rules Change

How to handle revisions in investment requirements.
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It's fairly common for mutual fund companies to change the minimum amounts they require new investors to pony up when entering a fund.

If it occurs with a fund you're already invested in, it's probably nothing to worry about. In fact, it may even be a good thing. But there are a few points you should keep in mind.

"It's not the kind of thing that happens all the time, but

changing minimum investment requirements is pretty common," says Christine Benz, director of mutual fund analysis for Morningstar. Generally, she adds, the trend has been for minimums to increase: The universe of investments available for less than $1,000 up front is very small.

A primary reason a fund may increase its minimums is if it's experiencing huge inflows, as is often the case with hot sectors -- think of energy over the past few months. When this happens, the fund's manager may have trouble putting all the money to work. In some cases, the fund may simply close to new investors, but often it will raise its initial investment requirements.

The Vanguard Group

has been most notable in raising its minimums, Benz says. The company previously increased the required initial investments on both its

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Vanguard Energy fund and

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Vanguard Selected Value fund to $25,000 from $3,000 "to put a chill on really hot asset inflows." (In some cases, if a fund does raise minimums for this reason, it may turn around and lower fees once the sector cools.)

Another case in which a fund may increase its minimums is if it isn't able to gain substantial assets or grow the accounts enough to make them profitable; both scenarios can make it tough to manage administrative costs.

Tom Roseen, a senior research analyst with Lipper, says that in the late '90s, a lot of funds were launching with minimum investments of $50 to $250. The idea was to attract those retail investors who had less money to invest than others.

However, he says, many of those fund families weren't able to cover their administrative costs and therefore had to raise minimums.

TIAA-CREF is a good example. The company had started several funds with $100 minimums, but because many of the accounts didn't attract sufficient assets, the company was forced to raise the minimums to $1,500 in order to cover costs.

Roseen says that there are still some fund families with initial requirements of $250 or $500; however, they often mandate that individuals set up automatic investment plans in order to qualify for the lower initial amounts.

While minimums on the whole are creeping up, funds do, on occasion, lower them.

For instance, Westwood Holdings Group recently announced it was lowering its initial investment on four mutual funds to $5,000 from $100,000.

Westwood said its reasons for slashing minimums was to offer institutional-quality investment vehicles to retail investors and to decrease expenses as the funds grow.

Both Benz and Roseen agree that generating greater visibility in the retail space and lowering expenses would likely be the motivation behind other fund companies' decisions to lower minimums as well.

The Bottom Line

So what does all this mean?

When a fund raises its minimums, Benz says, the gesture is usually shareholder-friendly.

"I think that what Vanguard has done has generally been quite good for shareholders," she says.

However, Benz adds, "It is an indication that some of these funds have seen hot money."

Investors, she says, should understand that if the manager doesn't invest that hot money, they could have a lot of cash on hand, which would dilute returns. Also, if a large number of investors wanted to redeem shares, the manager might be forced to raise cash at an inopportune time by selling holdings in the fund, which could generate capital gains distributions.

According to Roseen, when a fund hikes its minimum investment amounts, current investors are usually "grandfathered in" and are not forced to meet the requirements. In some cases, though, the fund may set up a minimum account balance and charge an administration fee to investors who drop below the thresholds.

Most funds, he says, give investors a period of time to reach a newly required asset level, but it's possible that investors who can't meet the requirements could be forced to redeem shares.

In terms of reduced minimums, Roseen adds that they can be good if the lower minimums allow a fund to reach a critical mass of total assets under management. "At a certain point, if they could draw more money, they may be able to lower expense ratios."

Also, he says, in taxable accounts, mutual funds have to pass out capital gains distributions, so if there are more people in the fund, the tax liability would be spread around. However, on the flip side, more investors could result in more redemptions.

Benz believes that lowering minimum investment requirements is on the whole "probably a neutral

for investors already in the fund, and it certainly could be a positive if you're looking at a manager that was off-limits to you before and you can now invest with him or her."