How.Can I Get Money Back.On.My.Taxes.Claiming.My Kid With No Job The Pros and (Mostly) Cons of Mutual Funds

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The Pros and (Mostly) Cons of Mutual Funds

Why buy a mutual fund?

The main reason investors buy mutual funds is diversification. A fund can contain from as few as twenty stocks up to several hundred. These can include stocks, bonds and cash. If your investable assets are less than $50,000, mutual funds can be an ideal tool for diversifying your portfolio. By investing, you are actually paying for a professional manager or team of managers to oversee your investment. Because mutual fund companies have huge amounts of money to invest, they may have the benefit of meeting directly with a company’s CEO and senior management before investing. This is certainly an advantage they have over an individual investor. If you’re busy living your life or don’t have the investment skills to research individual stocks, buying a mutual fund may be the ideal investment.

Need to sell fast, no problem!

Most investors think of a mutual fund as a long-term investment. However, selling a mortgage is as easy as selling a stock. If you place an order to buy or sell a mutual fund, you will receive the prices at the end of the day; not at the exact time you call to place your order.

The pitfalls of mutual funds

As with any security, mutual funds have their drawbacks. While a manager is required to invest based on the mutual fund’s prospectus, you don’t have control over which individual stocks your manager buys or sells. If you have an objection to a certain stock, such as your manager buying a stock of tobacco, you have no other option than to obviously fire the manager and buy back your shares.

Hot one year, cold the next

With a mutual fund, your money is pooled with other investors. This can create a huge problem for you and the fund manager. The money can pour into a warm mutual fund that you own. This could force the fund manager to hold that money in cash or invest in other securities outside the fund’s intended purpose. This is generally why a top performing fund may suffer from its return the following year. Remember, your mutual fund company also looks after their bottom line. The more money they have in assets under management, the more fees they will bring into their company.

In addition to inflows, there are paybacks that the fund manager needs to consider. In the event of a mass exodus from the fund you invested in, your fund manager has to sell shares to pay the shareholders who sold the fund. In many cases, a mutual fund may hold cash to account for repayments. This could cause problems for you and could hinder your total performance.

Taxes, taxes, taxes

A big problem and perhaps the biggest downside to investing in a mutual fund is the tax liabilities you will have at the end of the year. Whether your mutual fund manager has sold stock due to shareholder buyouts or simply sold stock because he believes that a particular stock within the mutual fund’s portfolio has reached its full return potential, your fund registers a capital gain. This capital gain is transferred to you and you must declare it as such in your tax return; even if you haven’t sold stock. These capital gains must be distributed to all shareholders by the end of the year. Typically your fund will report these gains in November or December. If you’re thinking about investing in a mutual fund later in the year, you need to call and ask when the distribution date will occur so you don’t get stuck with a tax bill. Here’s a double whammy: If your fund had capital gains on some stocks but still suffered a loss in NAV (net asset value), you may still be liable to pay tax on the capital gains it generated earlier in the year.

Note: This only applies to taxable accounts. If you’re a mutual fund investor and it’s held in a tax-free account like a 401k or IRA, the above doesn’t apply as you’re not taxed until you withdraw your money from your retirement funds.

Most fund managers don’t beat their benchmark

If you’re worrying a little, there’s more worrying news. Most fund managers fail their unmanaged benchmarks. Standard and Poor’s researchers conducted a study in 2006 and found that only 38% of large-cap fund managers managed to beat the S&P 500 (the standard benchmark against which a large-cap fund manager would be judged ) for a period of 3 years. Over a 5-year period, that number drops to 33%. It gets a lot worse for small-cap investors. Small-cap fund managers lagged the benchmark by 24% over a 3-year period, and only 21% beat the corresponding index over a 5-year period. This means that over a 5 year period you have a 67 to 79% chance of losing to an unmanaged index. Besides the reason listed above, there is the human factor. Throughout the history of the market, investors have sought the holy grail of investing. If the highest paid and smartest mutual fund managers haven’t found it after 100 years, chances are it doesn’t exist.

Taxes and Fees

As an investor, you are effectively paying commissions to a company to professionally invest your money for you. I can’t think of a single fund company that sends you an itemized bill at the end of the year. However, by law, mutual fund companies are required to submit a statement detailing each fee they charge. If you suffer from insomnia, they are highly recommended to read. Before investing, call the fund company and consult your financial planner. Research your investment before sending them your hard earned money. Remember, mutual funds collect their expenses from you regardless of how successful they have been.

Here is a highlight of mutual fund fees and expenses:

1) Class A Stock Fund Fee: These are usually known as “loaded funds” and will charge a 1-6% rate. Over time, this can take a huge payoff from your total return

2) Class B Stock Fund Fee: These are typically known as “backend loaded funds” and will charge a percentage when you sell your shares. Most charges on funds uploaded to the backend will dissipate if held for a number of years. For example, if you keep a back-end loaded fund for 5 years, the mutual fund company can waive the fee

3) Investment Management Fees: This money goes towards the advertising and salary expenses needed to manage the fund.

Knowing your fund’s expense ratio is crucial if you plan to have a successful investment career. The average expense ratio for a mutual fund is around 1.5%. This means that out of every $10,000 you invest, $150 is deducted for expenses, regardless of how well your mutual fund is performing.

Do you think expenses are not important? Consider this fact: $100,000 invested over 25 years will turn into $684,500 if you get an 8% return. If you squeeze in just another 2% more over a 25-year period, you’ll have nearly $1,100,000; a difference of $415,500. This could be the difference between sipping mojitos on the beach and having to take a job as a receptionist at Walmart in your “golden years.” Invest wisely and consult a financial advisor. Your future may depend on it.

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