Why Hanging On To Your Mutual Funds Might Be The Wrong Idea
Acting now may be critical due to tax considerations; fortunately there's an attractive investment class alternative worth exploring.
San Diego, CA (PRWEB) December 5, 2008 -- With the recent market decline, you may find yourself holding mutual funds in taxable accounts that are now in a net loss position. That may be true even if you have held the funds for many years because of the increase in tax basis over time from reinvested dividends and capital gains.
The popular press might encourage you to hold on to your positions if you can, based on the possibility of an eventual recovery. There are many factors to consider, but now might be an excellent time to liquidate your taxable mutual fund portfolio (or stock portfolio, for that matter) in order to capture the loss for tax purposes. If you don't have any taxable gains this year, you may still be able to deduct up to $3000 this year and you can carry the losses into the future. The value of this harvested tax loss might even be more valuable in the future if capital gain tax rates are raised.
In addition, if you liquidate your taxable mutual fund positions before the ex-dividend date (late November to early December for most funds), you may be able to dodge a nasty 2008 tax bite. "What capital gains?" you ask?
As active mutual fund managers buy and sell securities, they may generate net taxable gains on their portfolios. Since the fund doesn't pay taxes, the shareholders are "assessed" the tax in the form of a taxable capital gain dividend. With the steep decline in prices this year, many mutual fund shareholders have redeemed their shares, and this may increase the taxable gain distributed to the remaining shareholders. The possible result: an ugly double whammy for 2008: significant erosion of share value (non-tax deductible) and potentially large capital gains (fully taxable in a non-qualified account).
As of mid-November 2008, both the DOW and the S&P 500 had lost over 35% year to date. Let's say, for example, an account has dropped from $250,000 to $175,000. By selling now, you can lock in the $75,000 loss.
The question is: where to reinvest, and when? If you repurchase the same funds within 30 days, the wash sale rule applies and you can't use your losses. If you go into another fund within the same fund family, you may walk right into a long-term capital gain from the new fund. So you might achieve tax loss harvesting but still be exposed to the capital gain tax bite from the new fund.
And if you move to another fund family, you get the potential for the same tax bite, plus potential sales charges and the possibility of missing a significant up day in the market during the transfer. Recent volatility has resulted in daily price increases of more than 10% in a day, and the time required for writing a check from one vendor to another could cause you to miss out on a big recovery in a very short time.
If you want to harvest the tax loss and still maintain your invested position, one possible solution is an Exchange Traded Fund (ETF). ETFs are a fairly recent class of investment that combines the diversification of a mutual fund with the trading elements of an individual stock. First created in 1990 on the Toronto stock exchange, there are now thousands of ETFs available to investors worldwide.
The wisdom of using an ETF portfolio is supported by the results of a study released in 1986 titled Determinants of Portfolio Performance by Brinson, Hood and Beebower. They studied 91 large pension plans from 1974 to 1983 to determine what impact, if any, the managers had on portfolio performance. Surprisingly, when compared to their respective non-managed indexes, a whopping 93.5% of the portfolios' return was attributable to the sector they were in, as selected by the investment committee. Only 6.5% of the return was attributable to the managers' choices of individual stocks or bonds within the sector and to his or her timing of buys and sells. Adding insult to injury, the indexes returned 10.1% while the managers only returned 9.1%.
Several studies since then have shown that most mutual fund managers have not outperformed their comparable indexes over time. And when do investors jump in with a fund and its manager? According to one study of 294 funds listed in Barron's and Money magazine, usually right after they have been published at the top of the "Best Performing Funds" list. Due to this kind of "reactive" switching, many mutual fund investors get far less than the best returns of the funds they invest in.
So building an all-ETF portfolio using multiple indexes gives you a significant chance of outperforming the (often more expensive) mutual fund managers. This is pretty compelling on its own.
But there is also a long-term tax reason to consider ETFs over mutual funds. An ETF has very little, if any, internal trading activity, so it may be more tax-efficient. Because ETFs trade like a stock, they offer additional trading options, unlike mutual funds that only trade at the end of the day based on the closing price of their underlying securities. For all these reasons, it appears that the ETF portfolio is the smarter cousin of the more mainstream mutual fund.
To make the transition seamless, and avoid being out of the market, you can move your mutual funds into a brokerage account (open a new one if you don't have one already). Once there, the mutual funds can be sold and the ETFs purchased on the same day. You lock in the tax loss, avoid the mutual fund capital gain distribution and stay fully invested. An efficient readjustment of your assets.
There are several online resources that can help you build an all-ETF portfolio, including tools to help you build a highly correlated replacement portfolio for your liquidated positions. If you decide you need help, my team and I at Kingsroad Financial would welcome your call. Our fee structure has no front-end or back-end loads, plus we offer a performance-based fee schedule so that eligible clients pay a fee only when the account grows higher than the previous high-water mark. We would be happy to discuss this with you and welcome the opportunity to answer your questions.
Contact:
Larry Kriesmer, CLU, ChFC: is the Registered Principal of Kingsroad Financial Insurance Services, Inc., a Registered Investment Advisor.
5405 Morehouse Drive, Suite 230
San Diego, CA 92121
(858) 452-4930, ext. 101
Larry at kingsroadinc dot com
Bernard Surovsky, CFS
(858) 452-4930, ext. 106
Bernard at kingsroadinc dot com
1 Mutual Funds are sold by prospectus only.
2 Before liquidating any investment you should consider the effect of any sales charges, transaction fees, and taxes on the redemption as well as the same for what will be done with the proceeds, including suitability.
3 You are encouraged to seek advice from a qualified tax professional regarding your specific situation before taking any action based on information contained in this article. Because investor's situations and objectives vary, this information is not intended to indicate suitability for any particular investor, nor is it intended as tax or legal advice.
4 The current reduced 15% tax rate on eligible dividends and capital gains, previously scheduled to expire in 2008, has been extended through 2010 as a result of the Tax Increase Prevention and Reconciliation Act signed into law by President Bush on May 17, 2006 (P.L. 109-222). In 2011 these reduced tax rates will "sunset," or revert to the rates in effect before 2003, which were generally 20%.
5 The date on which a mutual fund shareholder is entitled to the dividend paid on the same or subsequent date. http://www.investopedia.com/terms/e/ex-dividend.asp
6 Contact your mutual fund vendor for an estimate of the capital gain distributions and ex-dividend dates for 2008.
7 The Dow Jones Industrial Average (DOW) consists of 30 of the largest and most widely held public companies in the United States. The S&P 500 Index is an unmanaged but commonly used measure of common stock total return performance. It is composed of 500 widely held common stocks listed on the NYSE, AMEX and OTC markets. Investment return and principal value of stocks will fluctuate with changes in market conditions. It is not possible to invest directly in an index.
8 http://finance.yahoo.com/
9 http://en.wikipedia.org/wiki/Wash_sale
10 October 13 and 28, 2008 both had increases over 10% on the DOW and S&P 500. http://finance.yahoo.com/
11 Please visit http://www.sec.gov/answers/etf.htm for a detailed description of ETFs.
12 Past Performance is no guarantee of future results.
13 The Educated Investor: Can Performance Persist? BAM Advisor Services, 2001
14 Truth in Mutual Fund Advertising: Evidence on Future Performance and Fund Flows, by Prem C. Jain and Joanna Shuang Wu.
15 Quantitative Analysis of Investor Behavior (QAIB), Dalbar, Inc. 2008
16 iShares Portfolio Construction Tools, http://us.ishares.com/tools/portfolio_tools.htm
17 Request a copy of our current Form ADV Part II, Schedule F for a full description of our fees and restrictions for performance based clients.
# # #
Post Comment:
Trackback URL: http://www.prweb.com/pingpr.php/U3F1YS1TcXVhLUhhbGYtRW1wdC1aZXRhLVNpbmctWmVybw==
Bookmark -
Del.icio.us |
Furl It |
Technorati |
Ask |
MyWeb |
Propeller |
Live Bookmarks |
Newsvine |
TailRank |
Reddit |
Slashdot |
Digg |
Stumbleupon |
Google Bookmarks |
Sphere |
Blink It |
Spurl
|
