Friday, April 13, 2012

Taxes - Selling a mutual fund

Yesterday was the last day of taxes for me in 2012.  I am finished for the year.  It was a good year of doing taxes, and I learned more this year than the two previous years.  My responsibilities increased a little more mainly due to my experience level.  Most of the volunteer preparers with the exception of the retirees would rather not do taxes ever again.  I keep coming back for more.

So, one of the things that happened on my last day was someone sold a mutual fund and purchased another fund.  This is a taxable event if done outside of a IRA or 401k.  I have seen it a couple times and it catches people by surprise.  Why?  Well...a certain company that I will not name, that in my opinion, preys on good military people tells them to sell one fund for another.  Typically if you come from another brokerage they do this to get you in their funds.  Sometimes which are loaded funds.  I still cannot believe that people buy these mutual funds.  For those that do not know what a loaded mutual fund is...they are a fund that charges you a sales charge upfront to buy into the fund.  Typically they charge 5%. 

Why would someone do this?  Good question!  Probably because they don't know any better, or they tell them that the management fees will be less than if you picked another fund.  Usually you can tell if a fund is loaded if they have Class A and Class B shares.  Class A shares are usually the loaded fund, and Class B is a deferred fund.  Meaning usually if you hold onto the fund for 6 years or something then you won't get charged a sales charge.  I'd put these funds into the get rich quick scams.  And just like the get rich quick aren't the one getting rich.

Let me take this a step further...I cannot believe people still buy mutual funds.  Mutual funds are what I call toddler funds.  Why toddler funds?  Because I could teach my 3 year old how to buy them.  They take little brainpower, research, management, or experience whatsoever.  Because of this you are paying someone additional money to get one of these mutual funds.  Plus you get lousy customer service many times.  Many brokers offer a more efficient way to park your money.  Investopedia talks about Exchange-Traded Funds (ETFs) and some of the advantages they have over mutual funds.  Some brokers even allows people to deposit money into one of their ETFs without charging a commission.

The main problem is that you need to do some accounting work when buying mutual funds, stocks, and bonds outside of a IRA.  If you have a regular taxable or brokerage account, every time you buy shares of the mutual fund you need to record how much you paid for the shares.  This is your cost basis.  It can be a record keeping nightmare...which is what happened to one of the tax customers we had.  The couple had bought shares since like 2000 and were putting money into the fund every month.  When the broker decided to change mutual funds to another...wham!  Taxable event!

So, prior to 2012...brokers were not responsible for tracking how much you paid for those mutual funds (after all it is expensive and requires good customer service, some of them did however track this for you).  So, the taxpayer gives me a 1099B that tells me when they sold the fund and the proceeds.  I ask, "How much did you pay for this fund?" should I know?

So, the customer ends up having to pay extra money to get several years worth of statements and needs to do all sorts of calculations to figure out the cost basis.  All this work and the customer probably ended up losing money on the fund.  Plus the tax clock is ticking, and the broker said it would take 2-3 days to e-mail the information.

If you ever experienced the...hey how come I got taxed when my mutual fund went down 50%...yeah not cool right?  But why?  Well...because like most money managers they sold all of the stocks that made money, and held onto all the loser stocks.  This causes a huge capital gain that must be passed on to the mutual fund holders (That's you!).  Isn't life grand?  Aren't you glad you purchased those toddler investments?  By the way...yes mutual funds are stocks and/or bonds.  Just and FYI...some people think they are something else.

So, after thinking that by purchasing a mutual fund it will be a simple investment with no work.  Think could be spending just as much time getting a mutual fund setup, tracking performance, dealing with a tax nightmare as you could if you purchased a rental property (with a good tenant) or stocks on your own.  Why did I start investing on my own?  I thought to myself...heck I can lose money just as well as the average mutual fund manager.  I was wrong, I lost much less.

At least you would probably learn something if you bought stocks, bonds, or real estate.  Plowing money into the mutual fund mystery machine is no different than playing the lottery or rolling the dice at the tables in Vegas.

Is there a better way?  Absolutely...but it requires reading, studying, experience, management, and most importantly teamwork.  Making money is a team sport, and when you invest in a mutual fund you aren't on the team.  You are a fan, who can't control anything.

Sometimes you might support a team that has a great coach (fund manager) who recruits and trains great players (stocks, bonds).  They might perform swimmingly.  In reality...most of the time, that doesn't happen.  Why?  Well if you follow recreation sports, you'll run into many terrible coaches and lousy players.

Action shot of Karen...I'm sure she'll complain and say this picture makes her look fat

My sister Karen plays semi-pro soccer for the Lady Saints.  She is great athlete...not as good as I was, but it's tough following a legend.  Karen used to play for a soccer team where any time she scored a goal the coach would sit her on the bench.  The coach would do this for all the girls on the team.  It got so crazy that some of them wouldn't want to score.

Karen then got on a different team with a different coach.  The first game she scored a goal and went to sit on the bench.  The coach said, "What are you doing?  Get back in there Karen!"

My mom explained to the coach her experiences with a previous coach.  I'm sure the conversation went something like..."That's dumb."

Folks...the same thing happens with mutual fund managers.  Right when they have that all-star stock making all kinds of money, they sell it when the market turns.  Then they will be stuck with all the mediocre stocks (or worse...think Lehman Brothers), and the fund will under perform for a long time.

That's my story and solid analogy.  What do you do next?  Go to my must read books...and start reading.  The only way you can find out how to do better with your money is knowledge.  If you don't know the questions to ask, then no one can help you.

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