Portfolio Review: Is it Time for a Change?

Is it time to sell your mutual fund? And what about highly-appreciated stocks?

As a mutual fund owner, how do you know when to stay and when to go? You probably remember receiving mailings from your mutual fund company — little booklets with lots of words in them (e.g. prospectuses and periodic reports). You may find it hard to make yourself read those things, but they do contain some critical information.

Every mutual fund issues prospectuses and quarterly/annual reports. Some of them might also seem to be difficult to read or understand. But it’s important to read and understand these documents, because they describe your fund’s investment strategies, risks, historical performance data, policies, and costs — and they can inform you of certain changes that you might find to be undesirable. Here are five specific changes to look for:

Style. If you own shares of a fund known for buying high-dividend, large capitalization, and it starts investing in alternative energy sources and startup biotech concerns, you may be taking on more risk than you care to. So be sure to keep an eye on your fund’s top holdings to ensure that they’re in line with the fund’s assigned objectives — and yours.

Management. This may not seem like a big deal. You might not even know the name of your current fund manager, let alone his or her replacement. But it can be important. A change in management isn’t necessarily a signal to sell, but it can result in a change in your fund’s investments. So if you receive notification of a fund manager change (possibly through a letter from your mutual fund company), read it to see if you can expect any changes, such as a modification of the investments in the portfolio. Additionally, it might be possible to look up the record of a new manager if he or she has managed other funds before.

Performance. Underperformance is not unusual, even for a quality fund. For example, the asset class a fund invests in may be suffering a cyclical decline, but the fund may be performing well relative to its benchmark. So you shouldn’t necessarily feel compelled to bail on a fund that’s having a down quarter or year. But keep an eye on performance by looking at each quarterly statement, and if you start to see a trend of questionable long-term returns, you may want to find out what’s happening.

Turnover. When a mutual fund sells the stocks in its portfolio, any capital gains realized from the sale of that stock are passed onto shareholders, who must pay any income taxes due on the gains (of course, capital losses are also passed along to shareholders in the same manner). As a result, higher portfolio turnover could result in higher income taxes. If you’re concerned about your taxes, keep an eye on the turnover rate of your fund.

Fees. Mutual funds are not required to keep fees at the level they were at when you originally purchased your shares — so make sure they don’t creep up unreasonably.

Of course, none of this is easy. Where do you find the answers to these questions in the documents you receive? We can help you make sense of your fund’s prospectus; just call our office or send in an email message. If you need assistance, don’t hesitate to ask us.

And Should You Risk Keeping a Highly Appreciated Investment?

Here are some questions you should ask if you have a highly appreciated asset or investment that you are considering selling:

1.) Have you held the investment for at least one full year? If you have, then the gain could be subject to the lower capital gain taxes. If not, any profits you realize from its sale will be taxed at your ordinary income tax rate which in many cases could be higher than your capital gains tax rates.

2.) Will your taxable income decrease in the future? If so, you may fall into a lower tax bracket and qualify for a lower tax rate on long-term capital gains later on. Right now, the long-term capital gains tax rate is 15% for taxpayers in the 25% tax bracket or higher. That rate drops to 5% for taxpayers below the 25% tax bracket (which would include married couples with a taxable income of as much as $59,400).

3.) When do you expect to need the money from the investment? Maybe you don’t expect to tap this asset for another 5 or 10 years. But doing so could possibly expose your portfolio to a greater degree of risk over the long term. The capital gain taxes may be a relatively smaller price to pay for the comfort that comes with a properly diversified portfolio. Plus over time, your diversified investments might potentially be able to recover the full amount you paid in capital gain taxes. Although diversification does not guarantee against the risk of loss in a declining market, it can help you to reduce the market volatility risk of your portfolio.

4.) Do you need the investment at all? If you feel you have sufficient funds to last the remainder of your life, you may never need this investment at all. That being the case, you may consider leaving the investment alone and letting it pass to an heir upon your death. Whoever receives the investment might be able to assume a step-up in cost basis, resulting in a smaller capital gain tax bill.

If you have an investment that has grown significantly but you’re not sure what to do with it, please contact us for a personal evaluation and tax analysis. Please use the use the CONTACT US link and let me know.

I look forward to meeting you!

Note: Mutual funds are investments involving risk and are offered by prospectus only. Investment return and principal value will fluctuate so that upon redemption an investor's shares may be worth more or less than original value. An investor should carefully consider the investment objectives, risks, charges and expenses of a fund before investing. The fund prospectus contains this and other information about the investment company. For a copy of a fund prospectus, please contact your financial advisor. Please also read the fund prospectus carefully prior to investing.

Sources: IRS Publications 544 and 550 (2005)