Thanks David and Maya - got the article. If you missed the following article in the Wall Street Journal it may be worth reading. Note that the manager of the low turnover Third Avenue Value Fund mentioned loves FSII as a long term play.
Once all the mutual fund investors start realizing that they are paying taxes on income from transactions by hyperactive fund managers maybe more will look to stocks such as FSII to get the long term capital gain rates. Now that the tax difference between the max income tax rate (39%) and capital gains rate (20%) is so large, I have a feeling the band will be marching our way. In any event, I don't think we will have to go looking for the music:
Best - Joe
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STOCKS OR STOCK FUNDS ? THE TAX-CUT PLAN
COULD TIP THE BALANCE FOR SOME INVESTORS
Maybe we've all been a little too quick to cash in our individual stocks and shift our life savings into mutual funds.
This unhappy thought is prompted by the tax bill passed by Congress last week. The huge cut in the capital-gains rate highlights a key weakness of the mutual-fund industry.
Indeed, it may encourage investors to take a second look at individual stocks.
What's the problem? Stock-fund managers, it seems, are a bit like children. They just can't sit still. Annual stock-fund portfolio turnover averages around 90%, which means managers are hanging onto their stocks for just over 13 months.
That's bad news for investors who hold their stock funds in a taxable account. Every year, funds are required to distribute their net realized capital gains to shareholders, who then have to pay taxes on the sums involved.
But, you cry, surely the tax cut makes these capital-gains distributions less painful for shareholders? After all, investments held for more than 12 months used to be taxed at a top rate of 28%. Now, thanks to the tax bill, stocks sold after 18 months are dunned at a maximum 20%, while stocks held more than 12 months but less than 18 months are taxed at a top rate of 28%.
The problem is, a lot of fund managers are so trigger-happy that they don't hang onto their stocks for even 12 months. If a stock is sold within a year, any profit counts as a short-term gain and, thus, it's taxable as ordinary income. For some investors, that means paying Uncle Sam at rates as high as 39.6%.
In fact, according to Chicago fund researcher Morningstar Inc., some 29% of the capital gains distributed by diversified U.S. stock funds in 1996 comprised short-term gains.
If stock-fund managers were at all concerned about their taxable shareholders, they would quit this short-term trading. Instead, they would look to hold stocks for at least 18 months, so that shareholders get taxed at the lowest capital-gains rate.
But Ross Levin, a financial planner in Minneapolis, reckons this years tax bill wont make a big difference in the way funds are managed. Mutual-fund managers will still focus on getting the highest total return. Taxes are a secondary consideration.
What to do? The typical stock fund, with its rapid-trading ways, remains a good choice for a retirement account, because you dont have to worry about the resulting tax bills. But if you re investing in a taxable account, you may want to pass on most stock funds and instead look for less-taxing ways to invest. One option is to buy and hold individual stocks.
That's an appealing strategy, because you control when stocks are sold and capital gains realized. Want to make sure you get taxed at the lowest capital-gains rate? Hang onto your stocks at least 18 months. Don't want to pay any capital-gains taxes this year? Don't sell any of your shares.
Even if you buy individual stocks, I would still keep a core holding of stock funds.
Consider putting maybe 70% of your stock-market money into mutual funds. If possible, use your retirement account to hold these funds.
Meanwhile, with your taxable account, buy individual stocks, but don't bet more than 5% of your total stock-market portfolio on any one company. If your stock portfolio is $100,000, that means each stock position is limited to $5,000 which is enough to buy 100 shares of most companies.
What if your portfolio is smaller? Settle on some companies that offer dividend reinvestment plans, buy a few shares of each and then use the shares to get enrolled in each company's plan. Once enrolled, these plans allow you to buy shares gradually, by investing $50 or $100 every month or every week.
If you are uncomfortable owning individual stocks, look to buy tax-efficient stock funds for your taxable account. "You want to buy low-turnover funds and index funds," Mr. Levin says.
Index funds simply buy the stocks that constitute a market index in an effort to match the index's performance. Because index funds rarely sell stocks, they tend to be tax-efficient. Meanwhile, among actively managed funds, Mr. Levin recommends low-turnover funds such as Third Avenue Value Fund, Tweedy Browne American Value Fund and White Oak Growth Stock Fund.
Also check out the small group of so-called tax-managed funds. Eaton Vance, Evergreen Keystone Funds, Nations Funds, T. Rowe Price Associates, Charles Schwab Corp. and Vanguard Group all offer funds that aim to keep their annual distributions to a minimum.
Because taxes are so damaging to investment performance, I would like to see more companies offer funds that are geared toward taxable shareholders. Indeed, fund companies should really offer two sets of funds, one set aimed at retirement investors and the other offered to tax- shareholders.
A pipe dream? I've been writing about mutual funds for 23 years, says Sheldon Jacobs, editor of the No-Load Fund Investor, an Irvington, N.Y., newsletter. "I've never heard of that. |
