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Yet Another Reason to Use an Index Fund
By JLP | August 25, 2006
Thursday’s Wall Street Journal had an interesting article by Eleanor Laise titled A Surprise Hit For Small Investors ($). The article talked about how mutual fund companies are changing managers more frequently and those changes are causing portfolio turnover which triggers capital gains distributions. The article states that as of July, the average mutual fund manager had been on the job 4.5 years, which is down 5.3 years in 2003.
For fund investors, new management can bring changes in investment strategy and the potential for improved performance. But it can also mean higher taxes for investors who hold a fund in a taxable account. That’s because a new manager, eager to put his or her stamp on a fund, often will sell unwanted holdings inherited from a predecessor. Such sales can generate capital gains, which are then distributed to individual investors who are responsible for paying taxes on them.
Capital gains aren’t a big deal if you hold your mutual fund in an IRA or 401(k). They can be a pain if you hold the mutual fund in a taxable account because the distributions are taxable whether you have them reinvested or not. The article also makes another good point:
Investors shouldn’t confuse capital-gains distributions with higher returns from their fund investments. However much a fund pays out to investors in capital gains, a like amount is subtracted from the fund’s net asset value. The end result: Investors haven’t gained anything from the distribution, but owe taxes anyway.
If you own mutual funds in a taxable account, consider using index funds, which typically have low turnover rates since they usually just buy and sell investments in order track changes in the underlying index. And, when an index fund changes managers, there’s usually no need for the new manager to make changes. If you like actively-managed mutual funds, try to hold them in tax-sheltered accounts like 401(k)s or IRAs, that way you don’t have to worry about the distributions.
It’s something to think about.
Topics: Index Funds, Investing, Mutual Funds |
August 26th, 2006 at 7:39 pm
Weekly Roundup - 08/25/06
August 28th, 2006 at 7:00 am
Should we even trust our money with these “young managers”? I’d be more worried about their abilties, having not had much experience. Also, the fact that they would sell off holdings because the holdings don’t fit his or her managing style and causing their clients to pay taxes that weren’t expected seems like immature management.
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