Day-Trading Funds

By Daniel Kadlec

The investment world has been turned upside down: Merrill Lynch, bastion of full-service, full-fee brokerage, is getting into the discount game; Charles Schwab, the original no-frills discounter, now charges some of the highest commissions online and offers a full menu of advice. Meanwhile, major exchanges are moving toward evening hours so day traders have more time to lose their money. This special market for insomniacs will eventually go 24 hours, all but ending the family meal and any shot at a good night's sleep.

Yet such developments are nothing compared with what's taking shape in the mutual-fund industry. Coming your way: intraday fund pricing and active trading of stock funds similar to what goes on daily with individual stocks. Already, mighty Fidelity Investments prices its 38 industry funds and their $20 billion in assets every hour, though it discourages frequent trades by assessing redemption fees. Virtually all other funds are priced just once a day, at the market close. But stepping up to twice-a-day pricing, at the least, seems likely. And with today's computing power, minute-by-minute pricing is increasingly plausible.

There are plenty of issues that the fund industry must sort out, such as how day trading of stock funds would influence long-term investors. Rapid trading could force fund managers to keep more cash on hand, hurting long-term results. For that and other reasons, the fund industry hasn't embraced the notion. But neither did the stock exchanges embrace No-Doz hours--until day traders demanded time to pursue their addiction at home. And neither did Merrill Schwab and Charles Lynch expect to be so much alike that you might confuse their names. These things happened because individuals have become the key force in the market. If individuals decide they want to day-trade funds, it will happen. There are now thousands of specialized funds to suit whims related to things like religion, sports, even astrology. Why not funds just for day traders as well?

I'm all for choice. But the fund industry may have overdone it already with 6,343 U.S.-based stock funds. A fund, at its core, is about easy, one-stop diversification. Yet many investors might as well buy individual stocks for all the fund options they feel obliged to consider. Recognizing how complex the world has become, influential fund tracker Lipper Analytical Services will expand its stock-fund categories this autumn from eight to 14. It's not just that there are more and different kinds of funds. Many managers, seeking to beat the market, stray from their investment styles. Lipper's new rating system is in part an effort to ferret out "style drift," an underrecognized risk for investors who may not know what they own.

Take the clue and check out your funds' holdings. Do the stocks in your equity income fund pay a dividend? If many do not, what you may actually own is a growth fund that duplicates another part of your portfolio. Is your growth fund chock full of Internet stocks? If so, maybe it duplicates your more aggressive investments. Of course, there are still plenty of properly managed funds out there. It's just that they're getting harder to recognize. If you own mutual funds because you like things simple, consider sticking to index funds. Most managers can't beat them, drift or no drift. You have a number of options beyond the overly popular S&P 500 index. And you'll always know what you own.

See time.com/personal for more on mutual funds. E-mail Dan at kadlec@time.com See him on CNNfn Tuesdays at 12:45 p.m. E.T.