Mark Brandon asked:


Mutual fund investors who hold their funds in a retirement account are not affected by this aspect, since income is tax-deferred in most cases. However, if you hold mutual funds in a taxable account, which includes a substantial portion of retirees, you will be doubly surprised this year. First, you will be hit with a tax bill whether or not you sold your fund during the year. To add insult to injury, you may be responsible for a large capital gains bill despite your fund being an overall loser for the year. Second — and few people know about this one yet — the expiration of three year tax loss carryforwards, means that your bill be larger this year than it’s been in the last five. Why? The losses sustained during the bear market of 2000-2002 enabled funds to offset gains in subsequent years. That expires this year. Lipper estimates that the average capital gains distribution is going to increase 50 percent this year (see Boston Globe).

How Did We Get Here?

Whether you are an individual or an organization, the IRS wants its cut of any income from capital gains and dividends. Mutual funds are not excluded. So, when your mutual fund manager sells positions for what you hope is a gain, that gain is taxable, regardless of whether there are offsetting losses. The same is true when a stockholding pays a dividend. For organizations that pass through these gains to the shareholders, the gains are taxable at the individual’s tax rate instead of the corporate tax rate. It is prudent to pass through these gains, since a large percentage of shareholdings are in non-taxable accounts, and few individuals that are in taxable accounts are in a higher bracket than the corporate rate.

You can’t fault the funds for choosing to pass through the gains. However, you can fault them for high turnover in their portfolios. In 25 years, funds have gone from an average turnover of 8 years (meaning that fifteen percent of their holdings are bought and sold in a year) to today’s average turnover of 100 percent. This means that in every year, all stocks are bought and sold. Some of the most egregious offenders turn over their portfolio five times in a year. The mutual fund industry has transitioned from buy-and-hold stewards of corporate America to being short-term, rent-a-stock traders in that time. Although evidence is unclear about why this has happened, the pessimist in me believes that it is because of soft dollar arrangements resulting in an incentive to trade frequently.

Why Should I Care?

High management and expense fees have already made it difficult to outperform their benchmarks consistently. Now, if you take into account that you will have to pay a larger bill to the tax man, that just means your performance suffers even more. If you lose one percent per year to taxes, that amounts to serious money over time. Over a 30 year saving period, this difference amounts to more than 25 percent of your ending net worth. Considering that this could make the difference between you running out of money before you die, it is not to be ignored.

What You Can Do About It

Index funds do not have high turnover. The only turnover they have is periodic rebalancing when their benchmark indexes change. This makes them more tax efficient.

An even better option is to engage First Sustainable to create a so-called Folio. This combines the technology available to a mutual fund to enable you to create your own diversified, asset-allocated mutual fund. You can buy fractional shares of individual stocks. This way, your only tax bill comes when you also do periodic rebalancing to suit your financial situation. To me, this is way more acceptable than swallowing a bill that was based on some conflicted manager’s financial situation.

tmpafford asked:


Has anyone done research to find out if there is an optimal day to make automatic purchases of mutual funds? Is the 2nd of the month better than the 18th? Is the 5th of the month better than the 25th?

I make monthly automatic purchases of mutual funds and I am just looking for the best day to choose. Does it make any real difference over 20 years or so?

Grassroots asked:


Aren’t annuities from mutual fund companies based on their mutual funds?

Cebuguys asked:


All companies I know i.e. Fidelity, Scottrade,
E-trade charge fees…selling/purchase of mutual funds. Which one is the best and least expensive?

Alan F asked:


I am a college student and I would love to invest in mutual funds. What sites you people usually used? For example for stocks they would get firms such as Etrade,Scottrade,Firsttrade,Zecco, etc. Is it the same thing? What should I look for toward in a fund? What is a morningstar rating of 5 stars? Any suggestions?

Benjamin Wise asked:


It seems a little odd to compare stocks to mutual funds. Actually, mutual funds are largely composed of stocks. It is important to make the distinction between the two as there are some very real advantages to using mutual funds.

It is fun to invest in individual stocks because each company has its own story to tell. However, you want to focus on making money! Investing is not a game and should not be taken lightly.

When you invest in mutual funds, you are able to diversify and reduce your risk of losing money. Do you think that those wealthy investors out there just put their money in a couple of stocks? No! Either they are investing in mutual funds or are buying large numbers of stocks.

When you purchase mutual funds, you are hiring a professional manager at a relatively inexpensive price. It would be a little off the wall to think that you have more knowledge than a mutual fund manager! Most managers have been around the track a number of times and have the academic credentials to back up their knowledge.

Mutual fund companies have the advantage of capitalizing on economies of scale because they pool investors’ monies together. Since these companies have large amounts of money to invest, they usually have personal contacts at many brokerage firms and often trade commission-free.

Mutual funds are easy to take care of. The bookkeeper is much more challenged when there are hundreds of stocks to keep track of!

Mutual funds are very liquid. Put in your order for money in the morning if you are short on cash, and by the time the market closes you may have a check waiting for you. Stocks, on the other hand, are much more difficult. It all depends upon what you have invested in. CDs are not at all liquid and bonds are difficult as well.

If you are new to investing then mutual funds may be the way to go. You can invest small increments of money at regular intervals and not have to pay a trading cost. If you invest in stocks, you will find that they carry high transaction fees. This makes it quite difficult for the small investor to realize a profit.

If you are a wealthy stock investor, then you have it made because you get preferential treatment from the brokers. Wealthy bank account holders usually get the red carpet treatment from the banks. However, mutual funds do not discriminate. Whether you only have a paltry $50 or a huge sum of $500,000, you all get the same manager, the same investment and the same account access.

Generally speaking, mutual funds have a much lower risk than stocks. This is largely to diversification which was mentioned earlier.

With stocks, there is always the worry that the company you are investing in will go belly up! With mutual funds, that is next to impossible.

As you can see, there are many advantages in investing in mutual funds over stocks. It is not to be said that you should never invest in stocks, but if you are just getting your feet wet with investing it would be best to go with mutual funds!

Robert Valentine asked:


A prospectus for a mutual fund describing that fund’s objectives, financial statements, and history probably doesn’t sound like a fun read to most people. But a prospectus is an important document that adds detail and helps potential investors become more informed when making investment decisions.

The added information has made a wealth of knowledge available on many mutual funds. This knowledge can potentially add to the confidence of an investor, should one take the time to get to know their mutual fund.

Even Congress has jumped into the mix. In 2005, Sen. Daniel Akaka from Hawaii proposed the Mutual Fund Transparency Act, which would call for increased disclosure of mutual fund fees, as well as taking a more critical look at mutual fund advertising. While the bill was referred to committee, it signaled an increasingly watchful eye being focused on mutual funds by Washington.

So what are some of the latest areas of mutual fund disclosure to be affected?

1) Holdings: In 2004, the Securities and Exchange Commission (SEC) ruled that mutual fund companies must post their portfolio holdings every quarter through the SEC’s Electronic Data Gathering, Analysis, and Retrieval System, known as EDGAR. This allows mutual fund investors to find out if, and how, the fund is following its stated investment objectives.

2) Fund Manager Compensation and Holdings: Fund managers are required to disclose how they are paid, and by fully knowing how the fund managers’ pay is structured, you can consider if their objectives and plans are similar to your own. Fund managers now must also disclose how much they have invested in the fund, within a certain dollar range.

3) Fees: Also in 2004, the SEC decided that mutual fund companies must disclose the amount of fees they charge per $1000 invested, as well as per $1000 invested assuming a hypothetical 5% gain. The increased transparency allows investors to compare fees to other mutual funds and decide if higher fees translate to performance.

4) Breakpoints: The SEC wants mutual fund companies to do more to inform investors of potential breakpoint discounts on large purchases.

These are just a few of the many disclosures and transparencies that are being encouraged or required by the SEC. The increased regulations are expected to continue in an effort to provide more information to investors.

To know every small detail of a specific mutual fund is a tedious task, but it is one that many financial professionals perform in order to give their clients informed recommendations. While you, as an investor aren’t expected to know everything, it does help to know that the extra information is available and more readily accessible than ever before. In the end, the more knowledge you have of your investment, the more confident you’ll be of your choice.

GC Tallyho asked:


I researched about 25 to 30 Mutual funds in order to buy six to ten funds and was surprised to see almost all went down in November. I would like to buy, but am not sure if Mutual funds have a history of going down in December. Does anybody know?

hamsterbabies asked:


I have money in a 529 plan and an IRA. I understand those and their tax implications. I don’t understand how you make money from investing in mutual funds just normally and the tax implications. If a mutual fund sells something… then you have to pay taxes on it? I am not quite sure how that process works. I know Vanguard has funds, but I’m not sure how investing in them without the tax benefits from the IRA and such can help me. Thank you.

Ryan Crown asked:


By nature Mutual Funds are not tax saving instruments but some mutual fund investment products also offers tax saving plans. Generally income that is earned from Mutual funds is categorized under two heads dividend and capital gains. Given that the tax implications can have a significant impact on the return earned it is necessary to understand the tax for both these heads of income. Income earned through dividends is tax free in the hands of the investor. The tax on most occasions is actually paid by the Mutual Fund Company itself. Investors who fall in the highest tax bracket should opt for the dividend option in mutual fund schemes. Capital gains from mutual funds are of two types - short term (1-3year) and long term (more than 5 years). This classification is based upon the period of holding. If the investment is sold within a year 15 days from the date of purchase, any capital gain made would be treated as a short term nature. Hence the tax deducted will be normal. If the mutual fund investment is sold after a year from the date of purchase, any capital gain made during that period will be treated as a long-term capital gain. Here the tax that would be deducted will depend on how long the investment is kept after a year prior to getting it sold. The longer the fund is kept the lesser the tax to be paid.

A Good Fund that could be used to invest upon is the equity linked saving schemes fund (ELSS). They are strong favorites for investing as they provide tax concessions on investments and are also exempt from long term capital gains tax. Apart from ELSS schemes, diversified equity schemes are a good investment considering that capital gains in equity funds below one year are taxed at a rate of 10% and over a year are tax-free. This option can be best exercised using Growth Funds. The primary objective of Growth Funds is to provide investors long-term growth of the capital invested. Dividend paid in Dividend Plans is tax free, and no distribution tax is deducted. However, every time we buy or sell equity shares a Securities Transaction Tax, STT, of 0.25% is paid and further when you redeem your investment, again STT is deducted from your redemption price.

Tax Planning & saving options requires a through study of the market conditions, especially if you are trying to do it in a period of slump. Proper Asset Allocation, research and the advice of the Fund Manager will definitely help. Long term capital loss can be set off only against long term capital gains. Short term capital can be set off against any capital gains, whether short term or long term.