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