Source: Morningstar
Do think that some funds will re-orient
their style to include more short term trading?
from Jeff
Q: The new tax legislation has removed the
restriction on mutual funds that theirs earnings can not contain more than 30% from short
term gains.
Considering this development, do think that some funds will
re-orient their style to include more short term trading?
Although the typical philosophy has been to buy and hold over the
long term, my own personal experience in stock trading is that significant yields can be
achieved by very short term trading....by adopting an almost day-trading approach.
What are your thoughts on this ? What funds do you see that will
benefit from the new legislation ?
A: The data that supports your position on
short term trading is pretty sparse. I am convinced that it cannot reliably add value
sufficient enough to cover the cost of the trades, management fees and expenses.
However, even if it were possible to add some value through active
trading, the new tax law may quickly eat up the gains for any taxable investor. All rates
of return are not the same!
At the end of the year, a fund must declare the net ordinary income
items, and the net long term gains they have generated. The tax burden is then apportioned
to each share. The investor gets to pay the tax. The tax directly reduces the investor's
net return.
Unrealized gains have an effective tax rate of zero. This is a very
good result from the investor's perspective. Long term capital gains now have a
maximum effective tax rate of 20%. Dividends, interest, and short term gains now
have an effective maximum tax rate of 39.5%. This is the very worst possible rate for
investors. It is almost exactly twice the long term rate. Day trading, if successful
generates only ordinary income taxation.
A rational taxable investor will prefer to defer all tax as long as
possible. He would like to determine when he pays the tax, and when he pays the tax, he
would like the rate to be as small as possible.
Because of the compounding effect, even small differences in net
rates of return will grow to staggering differences over a reasonable period of time.
A smart investor will have a very strong preference for funds that
generate the least possible tax. He will avoid funds with high turnover. His preferred
turnover rate will be zero.
So, a buy and hold strategy that generates the very smallest
possible tax along the way looks better and better. The case for indexing looks stronger
than ever.
Should I buy mutual funds on the margin?
from Brenda
Q: I moved all my
mutual funds to a brokerage account. Now I want to borrow against them to buy more mutual
funds. I have always heard that margin is very risky, but I do not see how. If I borrow
money at 8.25%, and invest in growth mutual funds for the long term, how can that be
risky? The broker's 8.25% is simple interest and the markets return is compounded. By my
thinking, I do not even have to get an annual return of much over 6.00% to break even,
over the long term. If the market can not return over 6.00% over the long term, none of us
are retiring anyway. What do you think?
A: Remember, there are no free lunches
on Wall Street.
Financial leverage of any kind increases risk as well as potential
rewards. If you were fifty percent leveraged, for instance, than the volatility of your
capital account would be about twice that of an unleveraged account. In a downturn, you
may get a margin call requiring you to make an additional contribution. If you are
unwilling or unable to make the additional contribution right away the brokerage house
will sell enough shares to bring your account back into line. You may sustain a loss, or
the sale of shares may trigger an unpleasant tax event. In a sustained market decline, the
interest will further eat into your capital account.
When bad things happen, investors can lose sight of the long term.
Investors often become discouraged when their capital accounts decline in value or even
just fail to grow promptly. Then they sell and lock in a real loss. Margin account holders
seem to suffer more from this effect than unleveraged accounts. Fear, greed and other
pesky emotions may also be leveraged by margin.
It's important to keep this in mind, because we haven't seen a
sustained market decline in a very long time. When the next sustained decline comes, as it
surely must, you can bet that it will not be fun for anybody. But, it will be torture for
accounts with margin. So, while I agree with your long term assumptions, investor behavior
may pose additional risks that can destroy the investment program. (I often think that
investor behavior is THE primary risk!)
In short, most investors should very carefully think out the
downside before they begin to leverage an account.
Where can I find info. on State Street
Research Equity Investment Fund?
Q: I can no longer find info on State Street
Research Equity Investment Fund. Old ticker was mssix. I'm even having a hard time finding
any info on State Street period.
A: I found it in a recent Morningstar
Principia Database. Call 1-800-882-0052
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