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What Is Shorting Expense?

Mutual funds that short have a higher expense ratio on average than ones that don’t.  Why is this?  Shorting entails additional expenses to obtain this hedging feature.  To short a stock, a margin account must be opened which entails the payment of interest.  Individuals pay a much higher interest rate than institutions such as mutual funds do.  In addition, when the shorted stock pays dividends, the short seller must return those dividends to the party from whom the stock was borrowed in order to be sold short.  Together, these interest and dividend expenses constitute "shorting expense."

 

There is one more expense, though – an indirect expense.  To the extent that the stocks shorted do pay dividends, their price typically falls by less than the value of the dividend. Therefore, when short-selling a dividend-paying stock, one might have to buy it back at a premium – sometimes as much as 25% – if the stock pays a dividend during the period in which one shorts it.




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