The capital gains problem has exposed an inherent flaw in mutual fund investing that Wall Street is beginning to exploit. The success of your mutual fund investment depends in part on the behavior of your fellow fund shareholders. Even if you remain loyal to a fund and do not sell a single share, shareholders who jump ship may impose an immediate cost on you, as could a rush of new investors. The recent market slide and related tax issues are helping spawn a new generation of investment vehicles, based on individual needs and circumstances, said Mark Hurley, chief executive of Undiscovered Managers in Dallas. Mutual funds are required to distribute to their shareholders gains they realize on the sale of investments, whether shareholders want to receive them or not.
Mutual funds continue to be a convenient, low-cost way to hold a diversified portfolio.
Peterson's research helps separate myth and reality about funds and taxes. For example, you might think that funds with above-average portfolio turnover would impose greater capital gains exposure on taxable investors. The claim is bogus, Peterson said. What matters, before and after tax considerations, is the long-term performance of the fund, which may be enhanced by rapid turnover. The same point applies to the concern that a fund that changes managers is more likely to impose a tax penalty, as the new manager sweeps out the old and in the new.