Why a High Turnover of Mutual Fund Investors is Your Problem Too
If you're a smart investor, you did a lot of homework before opening your mutual fund account.
You put some money into it, and you're keeping it there.
If you're still working and adding to it, you do that out of every paycheck.
You know that whenever you close out a mutual fund account, take your money and open an account at a new fund, you take a lot of risks.
But many people don't understand that.
They open up accounts, then change them, chasing the accounts that were hot last year.
Or perhaps chasing funds within families based on their expectations of what market sector is going to be hot next.
I don't know if it still exists, but there used to be newsletters for people to switch their Fidelity and Vanguard accounts.
In the 1950s, mutual fund owners averaged around a 5% turnover.
That means they held their accounts for an average of twenty years.
Turnover increased to about 8% in the 1960s (which means a holding period of around twelve and a half years), but kept increasing through the 1970s.
By the late 1990s it was as high as 31%, just over three years.
In between, in 1987, it spiked to 62%, no doubt because of the October 1987 crash, which convinced a lot of people to close out what was left of their mutual fund accounts.
Thanks to the tech wreck and bear market of 2002, average turnover went up to 42%.
It actually then decreased (perhaps because all the yellowbelly investors were already scared out) down to 24%.
It increased again to 36% with the financial crisis that started in 2007.
There's a possibility that one reason for the increase is retiring baby boomers.
They owned mutual funds while working and accumulating assets but, now they're no longer working, they're getting out of equities and placing their funds into more stable investments such as bonds, CDs, or even money market accounts.
However, if you keep your money in the fund, redemptions are a problem for you, because that means you're legally responsible for paying the taxes on their capital gains.
The legal obligation falls on those who are shareowners as of late in the year, usually in November.
The fund calculates the amount of short term and long term capital gains taxes realized during the year, then sends you the money late in December.
It may look like a Christmas bonus, but it's not.
It's a forced withdrawal.
You can have it reinvested back into the fund, but you still taxes on it.
And part of those capital gains are for the sale of stock shares to raise cash for the investors who withdrew funds earlier in the year.
Their share redemptions create a tax liability for you.
It may not seem fair, but that's the law.
So it's in everyone's best interest for all shareowners to remain in the fund, so the manager is not forced to sell stock to raise cash.
Unfortunately, the mutual fund manager is probably going to sell lots of stock and create a capital gains tax obligation for you anyway, because that's what most mutual fund managers do.
You put some money into it, and you're keeping it there.
If you're still working and adding to it, you do that out of every paycheck.
You know that whenever you close out a mutual fund account, take your money and open an account at a new fund, you take a lot of risks.
But many people don't understand that.
They open up accounts, then change them, chasing the accounts that were hot last year.
Or perhaps chasing funds within families based on their expectations of what market sector is going to be hot next.
I don't know if it still exists, but there used to be newsletters for people to switch their Fidelity and Vanguard accounts.
In the 1950s, mutual fund owners averaged around a 5% turnover.
That means they held their accounts for an average of twenty years.
Turnover increased to about 8% in the 1960s (which means a holding period of around twelve and a half years), but kept increasing through the 1970s.
By the late 1990s it was as high as 31%, just over three years.
In between, in 1987, it spiked to 62%, no doubt because of the October 1987 crash, which convinced a lot of people to close out what was left of their mutual fund accounts.
Thanks to the tech wreck and bear market of 2002, average turnover went up to 42%.
It actually then decreased (perhaps because all the yellowbelly investors were already scared out) down to 24%.
It increased again to 36% with the financial crisis that started in 2007.
There's a possibility that one reason for the increase is retiring baby boomers.
They owned mutual funds while working and accumulating assets but, now they're no longer working, they're getting out of equities and placing their funds into more stable investments such as bonds, CDs, or even money market accounts.
However, if you keep your money in the fund, redemptions are a problem for you, because that means you're legally responsible for paying the taxes on their capital gains.
The legal obligation falls on those who are shareowners as of late in the year, usually in November.
The fund calculates the amount of short term and long term capital gains taxes realized during the year, then sends you the money late in December.
It may look like a Christmas bonus, but it's not.
It's a forced withdrawal.
You can have it reinvested back into the fund, but you still taxes on it.
And part of those capital gains are for the sale of stock shares to raise cash for the investors who withdrew funds earlier in the year.
Their share redemptions create a tax liability for you.
It may not seem fair, but that's the law.
So it's in everyone's best interest for all shareowners to remain in the fund, so the manager is not forced to sell stock to raise cash.
Unfortunately, the mutual fund manager is probably going to sell lots of stock and create a capital gains tax obligation for you anyway, because that's what most mutual fund managers do.