| (ARA) - As tax time nears, many mutual fund | | | | more money you have invested, the higher your |
| investors are starting to wince. While most mutual | | | | fee. |
| funds' returns were down last year, their tax bill | | | | Undisclosed transaction costs. This is the fee that |
| remains high. | | | | a mutual fund pays to its broker to buy and sell |
| After years under-performing the S&P 500, the | | | | stocks. The fee is not found in a fund's |
| average US stock mutual fund finally beat the | | | | prospectus and is deducted from the fund's |
| index last year. But while the average fund was | | | | returns. The higher the fund's portfolio turnover |
| down just 0.37% v. the S&P 500's 9.1% drop, | | | | rate, the higher its transaction costs. |
| investors in the average fund actually lost around | | | | No control. You have no say over what stocks |
| 3% when you add in the fees and capital gains | | | | the fund owns. Some stocks may be ideal for |
| taxes they must pay, says James | | | | you while others are not. |
| O'Shaughnessy, CEO of and author of the | | | | Little knowledge. Because you don't know what |
| bestseller What Works on Wall Street. | | | | specific assets a mutual fund owns on a daily |
| "Mutual fund performance figures often leave out | | | | basis, you could wind up owning the same stocks |
| the taxes and some fees you are required to pay | | | | in several different funds. Or the types of stocks |
| as an investor," says O'Shaughnessy, a former | | | | the fund buys now may differ from the ones it |
| mutual fund manager and architect of a new | | | | set out to buy when you originally invested. |
| investment service that eliminates the big | | | | Significant tax hits. In addition to the capital gains |
| drawbacks of mutual funds. "The little guy is left | | | | taxes you pay when your fund manager actively |
| thinking he didn't do too badly when in fact he | | | | trades stocks, you also face "embedded capital |
| didn't do nearly as well as he thought." | | | | gains." These can occur when a fund you recently |
| Even the Securities and Exchange Commission is | | | | bought sells a stock it has held for many years. |
| fed up. Just weeks ago, the SEC set new rules | | | | Your tax hit on that trade will be equal to |
| requiring mutual funds to disclose what they | | | | someone who has the same amount invested but |
| haven't disclosed for years -- the impact of | | | | owned the fund for many years and profited |
| income taxes on a fund's performance. | | | | from that stock's long run-up in price. |
| In the 1990s, investors all but overlooked their | | | | What's the average mutual fund investor to do? |
| tax hit and the hidden costs in mutual fund | | | | Alternatives are emerging that provide individuals |
| investing. Strong and steady bull market fund | | | | with more control over their investments and |
| returns made taxes a non-issue. But now, as | | | | taxes. The Web-based services in this new |
| investors gear up to pay taxes in April, many are | | | | "personal fund" sector offer stock portfolios that |
| discovering the inequity of paying high taxes on | | | | are tailored to an individual investor's personal |
| funds that declined in value. | | | | financial goals. |
| How do taxes eat into fund returns? Let's say | | | | Instead of buying mutual fund shares, investors in |
| you invested $1,000 in the average mutual fund in | | | | personal funds buy an entire portfolio of stocks |
| January 2000. You would think that because the | | | | for a relatively low minimum investment. By |
| fund declined 0.37%, it left you with about $996 in | | | | owning the stocks in a personal fund, you control |
| December. Not too bad, you say, it could have | | | | your capital gains taxes by choosing when to buy |
| been worse. | | | | and sell stocks. You also know at all times the |
| But not so fast. Throughout the year, the | | | | stocks you own. |
| manager of the average mutual fund commonly | | | | The low cost of ownership and individual control |
| sells 92% of his fund's stocks in an attempt to | | | | of tax responsibilities offer individuals significant |
| boost returns. Who pays the capital gains taxes | | | | advantages over mutual funds and other popular |
| on his giddy trading activity? You do. In fact, you'll | | | | investment vehicles. As such, Forrester Research, |
| have to pay a higher, short-term tax rate on the | | | | an e-commerce research firm in Cambridge, |
| gains from assets the manger held for less than a | | | | Mass., predicted that more than $1 trillion will be |
| year. | | | | invested in personalized funds rather than mutual |
| That means you'll have to use your income tax | | | | funds over the next 10 years. |
| bracket to calculate your bill rather than the lower | | | | "The days when mutual fund investors have to |
| 20% rate charged on long-term gains. Your tax | | | | eat what they are served are over," says |
| rate on these gains could be as high as 50% after | | | | O'Shaughnessy of "Personal funds make it possible |
| you add up the your federal, state and local tax | | | | for every individual investor to own a |
| rates. | | | | professionally selected stock portfolio that is |
| But taxes are only half the story. The typical | | | | reasonably priced and designed for their needs |
| mutual fund also charges annual fees, an expense | | | | and goals." |
| ratio it uses to pay the fund manager, and | | | | ****** |
| transaction costs it uses to pay the fund's | | | | is one of several new services offering individual |
| brokerage expenses. | | | | investors personalized fund portfolios and -- |
| Now let's revisit that $1,000 you invested in the | | | | surprise -- the first headed by a former mutual |
| average mutual fund last January. By December, | | | | fund manager. |
| you would have paid about $18 in fees and about | | | | To begin investing at Netfolio, you pay $200 a |
| $12 in capital gains taxes. So you lost about $30 | | | | year or $20 a month to subscribe to its service. |
| on your $1,000 investment, not $3.70. That's | | | | Then you open a Bear Stearns account online at |
| about a 3% decline rather than the 0.37% drop | | | | the Netfolio site at no additional cost. |
| reported recently by fund-tracking firm Lipper Inc. | | | | To invest, you ask Netfolio to recommend |
| The 0.37% decline is the gross return of the | | | | personal funds that suit your investment |
| average US stock fund and does not include | | | | objectives. Or you can pick them on your own |
| taxes or fees. | | | | from Netfolio's list. Each personal fund comes with |
| "Mutual fund investors should be offended by the | | | | a recommended stock portfolio that you can |
| amount of taxes and fees they have to pay," | | | | customize prior to investment. |
| says O'Shaughnessy. "Mutual funds may seem like | | | | You can buy an entire portfolio of stocks in a |
| no-brainer investments but they can compromise | | | | personal fund with a minimum investment of just |
| your long-term savings potential. All the money | | | | $5,000. And there are no commissions when you |
| you spend on fees and short-term capital gains | | | | invest in Netfolio's personal funds online through |
| taxes could have remained invested and | | | | Bear Stearns. |
| compounding." | | | | "This type of personalized investment advice used |
| O'Shaughnessy has identified five big mutual fund | | | | to be available only to the superwealthy," |
| drawbacks: | | | | O'Shaughnessy says. "Now, thanks to the |
| High expense ratios. Investors pay a fee for the | | | | Internet, individual investors everywhere can |
| privilege of owning shares. That fee goes to the | | | | access the same type of service through their |
| fund's manager. But instead of a flat amount, the | | | | computer. |
| fee is based on your assets in the fund. The | | | | |