Why Or How To Hold Mutual Fund Investments In Taxable Accounts?
Posted by admin on 17 Apr 2008 6:02 pm. Filed under Investing.
tc asked:
Many mutual funds have very recently paid out year-end distributions. For example, let’s say I own a fund worth $1000 that distributes 10%, or $100. The investment is still worth $1000 even though the fund shares have declined in price by 10%, but if you’re in the 25% tax bracket, and the distribution is short-term capital gains and income, then I have another $25 to pay in income taxes due solely to the distribution. In other words, if you figure the effect of the income taxes, the net has just declined from $1000 to $975.
Many mutual funds have very recently paid out year-end distributions. For example, let’s say I own a fund worth $1000 that distributes 10%, or $100. The investment is still worth $1000 even though the fund shares have declined in price by 10%, but if you’re in the 25% tax bracket, and the distribution is short-term capital gains and income, then I have another $25 to pay in income taxes due solely to the distribution. In other words, if you figure the effect of the income taxes, the net has just declined from $1000 to $975.
I realize my concern goes away if the account is in an IRA, but this question is specific to a non-IRA or non-Roth account. So then, what is the sense of holdlng mutual fund investments in taxable accounts?
On April 17th, 2008 at 9:20 pm
That is certainly a concern with mutual funds in general, but there is a slight correction that needs to be made to your analysis. Most distributions are in fact long term capital gains wich are taxed at a favorable tax rate. Not all but most.
Now if you were to invest in an index fund, the distributions would be much less because the realized captial gains are much less. One of the big advantages of index funds.
The main advantage of holding mutual funds in taxable accounts is that they allow investors to hold a diversified portfolio of investments with a small investment thus reducing thier specific risk. Holding $1000 worth of a mutual fund is a lot less risky than holding $1000 worth of particular equities.
There is also the problem of access to funds. If all of your investments are squirreled away in an IRA, you are not going to have access to them if the need arises without suffering a tax liability.
On April 18th, 2008 at 8:17 am
I hold some mutual funds in a taxable account just in case i manage to save enough to retire early i wont have to take penalties by getting at my IRA, plus if something comes up 5 or 10 years from now like a great real estate opportunity i can take it out of my taxable account with no penalty,
most of my money is in retirement accounts,but maybe 1/4 is in taxable accounts