In nearly all mutual funds an investor can order any number of shares above a low minimum, pay for them at the currently asked price per share, and receive a certificate of ownership. This is the old-style method of buying, and it still suits a good many investors. Each purchase is a complete transaction, and a buyer gives no hint as to when or whose stock, or how much, he intends to buy next time.
But the old method is cumbersome for small payments and is confusing to investors not accustomed to buying anything whose price fluctuates continuously. Also, many buyers like to be more or less committed to a program. So nearly all mutual funds now offer the option of a different way of buying their shares. While these plans differ in several respects, it seems they all agree on these minimum rules:
1. An investor signs an application form, whose acceptance by the company puts the plan into operation. This form says he is going to make frequent purchases of the fund's shares; but in some plans, this is merely a statement of intention, with no obligation.
2. He sends in dollar payments, without needing to know the current price per share.
3. At each payment, the company sends him a receipt showing he has bought so many whole shares, plus whatever fraction of a share uses up all of his payment at the current price.
4. The company keeps track of his total purchases to date under the plan, but does not send him a formal stock certificate unless he requests it, or the plan is ended. This relieves him of record-keeping, also of safekeeping of stock certificates.
5. He can cancel the plan, or redeem part of his shares, at any time.
6. He has the option of giving the company standing instructions not to send him dividends in cash but to buy new shares for him. A stockholder can arrange separately for this automatic reinvesting of dividends without joining the rest of the plan.
In some mutual-fund plans, these rules cover all of the main points. These plans leave an investor completely free to send in any dollar amount, whenever he chooses. Many other funds set a minimum size of payments, typical amounts being $250 to the initial payment, $25 or $50 on repeats. Usually an investor can build up to the initial minimum by buying shares in the regular old way until he has enough to join a plan. No extra charges are involved in the plans mentioned thus far.
Other plans have much stricter rules, and many of them offer life insurance as an option. An investor signs up to pay a certain uniform dollar amount monthly for ten years, the minimum being $20 the first month and $10 thereafter. The company reminds him each month that another payment is due. Out of an investor's payments during the first year, some companies take heavy selling expenses before buying shares with the remainder, so that if he drops the plan in the first year or two, he suffers a severe penalty. That is why we call them "penalty plans."
Even if he completes the 10-year program on time, with no misses, the total fees charged are higher than on non-penalty plans, and the extra fee is larger on small payments such as $10 or $20. (Incidentally, on an ordinary life-insurance policy sold direct by an insurance company, the penalty for early quitting is more severe than in the mutual-fund penalty plans.)
Investors must be on the look out for these penalty plans and avoid them at all costs -- or it could cost the investor dearly.