A recent article in USA Today attempted to explain why investors returns receive are not the same as those announced by the mutual fund. The difference is often caused by the sales expenses and taxes on income and capital gains generated by the Fund.
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You can eliminate charges by purchasing a fund vacuum or by combining the funds in a family of funds to reach the breakpoint in which loads are not charged. Lowering the tax hit is more difficult, unless your funds in a tax deferred account. Even then, the fees are deferred and not avoided. When you withdraw your funds, you will be subject to taxes at your marginal rate in time.
Here is the best way to get the advertised or better returns: buy a portfolio diversified funds worldwide low-cost index. In their futile efforts often to beat the markets, actively managed mutual funds (where the Fund Manager attempts to fight a designated benchmark) to engage in turnover rates high in their portfolios. This excessive trade generates taxes and expenses trade for mutual fund investors. In 2010, the turnover of the Schwab S & P 500 fund index was only 3 per cent, compared with a turnover of 39% for the fidelity Contrafund.
Other fees that reduce the performance after tax for the actively managed fund investors. It commissions, cash drag, transaction costs and high spending reports. The impact on investors of these costs is important. The average equity fund had a return of 11.2% over 15 years from 1984 to 1998 bull market. This is not bad until you consider that the 15.8% return of the index fund market during the same period.
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The difference in statements before and after taxes between actively managed and index fund is striking. For the period of 25 years from January 1980 to December 2005, $10,000 invested in the average actively managed equity fund would have pushed to $108,347 before tax. The same investment in S & P 500 Index Fund would have grown to $181,758. The difference in performance after tax is even more important. The active investor funds got $71,727 from an end value after tax of $158,975 for the investor index funds.
A study by the co-founder of Vanguard John Bogle has concluded that, during the period from 1984 to 1998, investors in actively managed funds retained only 47% of the cumulative returns of their funds. Investors in index funds kept 87 per cent of their statements.
Index fund investors may reduce their tax hit yet further by investing in a tax or effective tax managed funds. These fund managers use tax savings strategies, such as the tax loss harvesting, further reduce the already low impact of taxes on investors. Most active fund managers do pay attention to tax returns after their funds. They include that investors focus on published statements, before taxes and do not calculate the impact of taxes.
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While the financial media deals with loads and breakpoints, your should focus on avoiding all actively managed funds and exclusively investing in index funds. You won't have to worry about to reach the performance of your funds. After tax of your portfolio performance is likely significantly higher than those of a comparable portfolio, actively managed.
Dan Solin is a senior vice president of index funds advisors. He is the author of the New York Times best sellers The Smartest investment book you'll ever read, The Smartest 401 book you'll never read and The Smartest retirement book you'll never read. His new book, the Smartest portfolio you ever own, will be released in September 2011.
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