Mutual fund management professionals are staying on the job much less these days, perhaps due to tighter industry competition: A study showed that, the typical mutual fund manager had been on the job for 4.44 years, down from 5.26 yrs in September 2004.
For mutual fund investors, adjustments in personnel may potentially be very good as new managers can deliver new suggestions to the fund and potentially improve performance. But these brand new suggestions are a double-edged sword. In the event the new manager sells undesirable holdings inherited from a predecessor, he or she may produce capital gains, which would be allocated to the fund's shareholders and create for you just the complete opposite of income tax relief. You would be hit with a tax liability just for holding the fund shares.
As an example, think about the typical annual portfolio turnover for a growth mutual fund. Portfolio turnover measures how much buying and selling a fund incurs. For example, a portfolio turnover of 100% means the fund holds shares, on average, for 1 year. A portfolio turnover of 200% indicates the fund holds stocks for six months. The average growth fund has a turnover of 100%.
Just how much can portfolio turnover affect you? As an example, in the spring of 2006, one Fidelity fund distributed $9.7 billion, nearly one-fifth of the fund's net asset value, in capital gains and dividends after new fund manager reshuffled the large fund's portfolio. Investors would've needed to search for tax offsets along with other investment strategies in order to experience any income tax relief that year. Without realizing it was coming, each shareholder received a shocking 1099 form in January showing that they owed some unexpected taxes.
According to Morningstar, the typical yearly portfolio turnover for a fund manager who has been on the job 2 yrs or less is 98.65%, compared to 87.67% for a fund manager who has been managing a fund longer than two years. The lower the turnover, the greater the potential tax relief from holding shares of the fund - or at least the less shocking the 1099 form.
Does that mean you need to leave a fund that has a portfolio manager change? Not necessarily. Doing this can magnify your tax hit as in addition to owing capital gains taxes on the fund's capital gains, you'll own capital gains taxes on your sale (i.e. the potential profit on the fund shares you own).
Instead, you might want to gain a sense of how much a brand new manager is changing the fund by taking a look at the fund's portfolio turnover. You may also wish to evaluate a tax hit in light of a fund's past efficiency. You may also look at the previous funds that the new manager has directed in the past. He may be an advocate of a low turnover strategy that brings you income tax relief. If your fund has had a good average annual return over the past five yrs, it may be simpler to tolerate the capital gains taxes. But when your fund performs badly, capital gains taxes might be adding insult to injury.
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