Viewing entries tagged
taxes

Hidden Taxes Still Cost Money

A recent article from Russell Investment only confirms what some of us already know; 

"Your mutual funds taxes are impeding your progress"

The article is a good one and kudos to Russell Investments on writing it. It confirms for us however, factors we've known for a long time. Your investments are incredibly expensive and those costs make the chances of your meeting your long term investment goals or any financial goal for that matter, daunting at best. 

If the math is correct in the article (we have a lot of faith in the Russell organization, so let's assume it is ok?) a taxable capital gain of nearly $8,969 is bad enough, but with having 15% of that being a short term distribution, the tax impact is considerable. 

Look we're not saying that all or even a majority of your investment decisions should be driven by tax factors, but if they aren't driven by them, clearly they should at least be a consideration in the grand scheme of things shouldn't they? We think that they should especially when they can be avoided without too much effort. 

As we've written before, how may layers of costs can the mutual fund industry heap on investors before they wake up and stop the insanity? 

If we have expense ratios (the cost of operating the fund) of about 1.3% to 1.5% of assets (Source: Investopedia) and if the Wall Street Journal was right a few years back that "undisclosed trading costs to mutual fund investors was annually about equal to the funds expense ratio, then we've got just the cost before commissions or fees of owning the damn things at about 2.6% to 3.0% per year.

Add to that, either commissions or advisor fees and you've got costs of about 3.0% to 4.0% per year. Now let's factor in taxes because if we take the hypothetical investor from the Investopedia article, taxes in his case were ANOTHER 2.4% getting the total costs to about 5.4% to 6.4%. 

Ever wonder why actively managed mutual funds can't beat an index fund or passive ETF with any consistency? If you did, just go back and re-read the last paragraph again. 

So, let's take and example for a minute. Let's say we're trying to pay for a child's college education in ten years. Here's what we can reasonably count on for our math.

1. The average cost of a college education will come in at roughly 2x the inflation rate. For the sake of this post, let's consider the inflation rate to be 3.1%. That means that the average college tuition will increase year-over-year by about 6.2% so we have at least earn that

2. We then have to earn enough to cover the expense ratio, another let's say 1.3%, so now our investment has to earn 7.5% just to keep pace

3. Then we have to cover the trading costs of another 1.3% so our "required earnings" are not up to 8.8% and then; 

We have to earn enough to cover any tax bill and any fees or commissions. 

If you believe that's going to happen I've got an actively managed mutual fund I can sell you. (That bridge reference just wasn't appropriate here, even though based on recent infrastructure analysis "it" has about as much of a chance as falling down on the job as your actively managed mutual fund will.) 

If you're saving for college and you can clear that probably about 9% a year hurdle, you're on your way to making some real money.....just one problem.  If you make 11% you're not keeping much of any of it now are you? 

Nuveen investments some 20 years ago used to run an add campaign that said, "it's not what you earn, it's what you keep." 

I wish I'd have though of it, because it may be the only thing about investing that still rings true today. 

I know what your saying, that since Barry Capital doesn't use active management (we'd prefer that you keep them money that otherwise gets wasted) we've got a bias. Well, you'd be right on both counts, we don't use active management and we have a bias. Our bias just happens to be spreading around the world.  If you've got 81 mintues to spare you can check it out here. 

 

As I wrap this up, I just took a look at the four largest portfolios that we manage in each of our core investment strategies.  The grand total on this years (2014) capital gain distributions were: $0. (Unless we rebalanced your portfolio at some point and realized a gain as a result of that effort, an effort we can assure you at some point you'll be glad we undertook on your behalf.)

If you can't change your investment program, you'll have a tough time. If you can change it please do so for your own benefit. 

We'd be happy to help. 


The Tax Man Cometh and Your Investment Returns Goeth...away?

Clearly, 2013 was a great year in the market. But just like Halloween, your 2014 return is coming around to haunt you. 

Last weeks dip in the market prompted many mutual funds to sell of considerable gains that they had carried forward from 2013. Both stock and bond mutual fund managers were sitting pretty, with built up gains that they had yet to get out of, poised but waiting for the right moment. And, sure enough for many, last weeks dip in the market was the exit point. 

Mutual funds must distribute their realized gains to shareholders. When that happens, the shareholders must then pick up those capital gains on their tax returns. The cost of paying those taxes should be considered a direct reduction in your return because they are in fact a direct expense of owning your mutual fund investment. 

A recent Reuters article goes on to say that stock mutual fund investors could be hit worst of all. Morningstar Analyst Russel Kinnel estimates that stock funds could be sitting on gains of around 20% and could end up paying the majority of that out as gains to shareholders. 

Coupled with ongoing expense ratios for mutual funds in the range of about 1.4% per year and adding in undisclosed trading costs of what amounts to another 1% or so, the typical investor who owns an actively managed mutual fund is paying somewhere around 2.4% of their portfolio value every year in expenses, and that's before you factor in taxes and commissions. No wonder American's are having such a hard time building a nest egg for retirement or any other goal. 

This coming April might be especially daunting for investors.  Many people had carry-over losses from the last market downturn and had been able to offset gains for a few years with those losses, but for many, the pool of available offsets has run out. 

The Rise of ETF's and Indexing

More and more investors are realizing that investing is a zero-sum game. There's only so much money to go around.  One mutual fund managers 10% gain has to be by definition another mutual fund managers 10% loss. While fund managers struggle to out perform a passive benchmark (the S&P 500 would be one example of a passive benchmark) they all seem to have forgotten that their desire to "beat the market" is inexorably complicated by the fact that by and large, they are the market. 

Indexing and the use of Exchange Traded Funds (ETF's) can minimize many of the costs that an investor faces. Not only is there no "management" team who have to have salaries paid, space rented, research conducted and distribution costs paid, but indexing by definition will largely eliminate the costs of any active trading in the portfolio as well. That could amount to a reduction in expenses to the end Client of as much as 2/3 over an "active" strategy. 

And there's a potentially more important payoff; the possibility of higher and more consistent performance. 

No one can guarantee or assure performance improvements, we all know that. But a recent study by Dimensional Fund Advisors shows the following factors as it relates to "active" vs. "passive" investing; 

  • LARGE CAP CORE- active fails to outperform passive roughly 95% of the time
  • MID CAP CORE- active fails to outperform passive roughly 94% of the time

(Note: the best performing active option is in Small Company Value with a 54% in Small Company Value as noted below.)

And even where active stands a fighting chance in asset classes such as Small Company Equity, active still fails to beat a passive bet 68% of the time in Small Company Core, 77% of the time in Small Company Growth and 54% of the time in Small Company Value. 

The track record on bond funds in the "active" vs. "passive" debate is even worse, where Municipal Bond Funds  (failing 98% of the time), Intermediate Municipal Bond Funds (failing 100% of the time), Short Term Municipal Funds (failing 96% of the time), High Yield Bond Funds (failing 97% of the time) and TIPS (failing 100% of the time) make an active management decision a benefit to the sales person and the fund company but clearly not the investor. 

For the record, no one can tell you what active funds will [a] beat a passive strategy, [b] that beating a passive strategy in one period provides any assurance that the same manager will beat it in the next or [c] that beating a passive option one out of five out of ten years will accumulate more money than the passive option since that would be dependent on what the actual returns were period by period. 

If you've chosen an active management bent to your investment program, the research is pretty clear, it'll be expensive in terms of costs, expensive in terms of returns and expensive from a tax standpoint. 

But how much difference does it really make?

On a $500,000 portfolio over a twenty year period a 2% difference in returns is the difference between $1,603,567 and $2,330,478 or roughly $700,000. 

Want to make progress toward retirement, college funding, buying a vacation home or just simply living out your life in reasonable comfort?  I'll bet $700,000 in additional wealth will help with no additional out of pocket cost!

Last year, PBS Frontline reviewed for everyone the negative impact of active management costs AND THAT WAS IN RETIREMENT ACCOUNTS.  That's important because of course, the implications for taxes aren't considered in retirement accounts. Taxes would be an additional costs on top of the expenses and any commissions paid.  I'd urge you to watch this series which is still available on the Frontline website. (Note: If you click on the graphic above it'll take you there.)

At Barry Capital we realized a long time ago that active management was, in our opinion, a fools game.  It's a story, artfully told about how, with time, talent and tenacity (and a whole lot of your money) a dedicate individual or group of individuals is going to show you how to beat the market. 

One small problem.....there's no chance that it will happen with enough frequency to make anyone any more money. Unless you're the fund company that is.