Redemption fee

Redemption fees are charged by many Vanguard funds (and non-Vanguard funds as well) to discourage short-term trading or to compensate long-term holders for the expenses caused by short-term trading. Unlike loads or commissions charged by brokers, these fees are paid back to the fund, and thus work to the benefit of fundholders.

Short-term trading fees
All of Vanguard's international funds charge some type of redemption fee; the most common fee is a 2% charge on shares held less than two months. This fee discourages market timers from investing in these funds; the high transaction costs in international markets would otherwise be passed on to shareholders if market timers moved a lot of money into or out of a fund.

Many aggressive and sector funds charge a 1% redemption fee on shares held less than one year. Again, the fees are designed to keep short-term traders out of these funds; none of these funds are suitable for an investment of less than one year.

Five-year fees on tax-managed funds
The Vanguard Tax-Managed Funds charge a 1% fee on sales of shares held less than five years. This fee is intended to help with the tax management of the funds; when fundholders sell shares, the fund must sell stock and might be forced to realize capital gains.

This fee has the side effect of imposing a cost on tax loss harvesting and rebalancing, which even long-term investors would be likely to do in less than five years. Therefore, these funds are most attractive for very long-term investors who will pay the fees only in the first five years, and for investors who are still adding to their portfolios and can rebalance with new money. Such investors expect to pay less in fees than the average investor in the fund, and will therefore earn more from the fund with fees than from a similar fund without fees.

Permanent redemption fees
A few funds which trade stocks with high trading costs charge a redemption fee on all shares sold, for the same reason that these funds and many other funds charge a purchase fee; selling stocks causes a significant cost to the fund, and the cost is charged to the investors who are responsible for it. The purchase and redemption fees tend to decrease as the fund becomes larger.

The following Vanguard funds charge permanent redemption fees:


 * Vanguard Emerging Markets Stock Index Fund (0.25%, also 0.50% purchase fee)
 * Vanguard FTSE All-World ex-US Small-Cap Index Fund] (0.75%, also 0.75% purchase fee)

How Vanguard computes the fees
For funds with non-permanent redemption fees, shares purchased with reinvested distributions are exempt from the fee, and other shares are assumed to be sold on a first-in-first-out basis, even if you use a different accounting method for tax purposes. Therefore, once you have held the fund for longer than the fee period, you can usually rebalance or sell recently purchased shares for tax loss harvesting without paying a fee.

How to avoid the fees
If you are considering investing in a fund with a redemption fee for less than the fee period (for example, as a temporary replacement while tax loss harvesting), use an ETF instead; the commissions and bid-ask spreads on buying and selling the ETF are likely to be less than the redemption fee. Most of the international index funds have an ETF share class.

If you would have to pay a fee to redeem a fund which has an ETF share class, you can avoid the fee by converting to ETF shares (this costs $50 if you are not Flagship), and then selling the ETF on the stock market. Compare the cost of the conversion, and the commission and spread on the ETF sale, to the redemption fee.

Do not use the Vanguard Tax-Managed Funds if there is a significant probability you will need the money within five years. However, do not let the fee deter you from harvesting a significant tax loss (more than 10%) if one occurs while you hold the fund; the tax savings will be more than the fee.

If you are considering a fund with a permanent redemption fee as a long-term investment, you might ignore the potential fee, as the fee is likely to become much lower or go away by the time you actually sell your shares. However, you should also consider the ETF share class, particularly if you do not expect to reach Admiral shares in the fund and will thus have higher ongoing costs.