Why You Should Not Own Mutual Funds

Taxes take a large bite out of taxable mutual funds (MF). Recent tax break laws will eventually come to an end and it would be smart for investors to keep an eye on one of the main drags on performance, taxes.

One key reason why mutual funds paid out such hefty taxable distributions in recent years is because they can no longer carry forward the steep losses incurred during the 2000-2002 bear market, which had been used to offset gains in recent years.

The estimated taxes paid by taxable mutual funds investors increased 42 percent from those paid in 2006. Buy-and-hold taxable (MF) holders surrendered a record-setting $33.8 billion in taxes to the government, surpassing 2000’s record amount of $31.3 billion!

Over the past 20 years, the average investor in a taxable stock fund gave up the equivalent of between 17 percent and 44 percent of their returns to taxes. In 2006, the tax bite amounted to a hefty 1.3 percent of assets, which surpasses the average stock fund expense ratio of 1.2 percent.

Mutual funds probably have no place in high-net-worth client portfolios. There are many strong reasons in favor of this position but most immediately – you have probably noticed that every year when you receive your statements with end-of-year form 1099s in the mailbox and discover that a sizeable amount of your hard-earned cash is going to Uncle Sam.

If you were to subtract 50 percent (93 million plus) of mutual fund holders who hold stock fund assets in tax-free accounts such as 401(k) plans and IRAs, and a small number in institutional and trust funds that make a few investors tax-exempt, this would leave around 48 percent of the nation’s (MF) investors in taxable funds.

The SEC says the average investor in this taxable group loses 2.5 percent of annual returns to taxes each year, while other research puts it at 3 percent. Throughout your lifetime you can see that capital gains taxes will reduce invest-able income substantially when you retire.

You know the figures. Sure, during the 1980s and 1990s, people made money by selectively investing in mutual funds. Even today, it still can be done; however, more than 90 percent of them have underperformed the stock market as a whole for the past five years. You can get better odds at the horse track.

It works like this: An (MF) with higher trading costs and built-in high tax limitations create a post-tax return that potentially delivers fewer returns than a similar separate account.

These funds kill their potential for becoming performance superstars by their high volume of trading and killer fee structure. Too much trading causes increased taxes, while high fees reduce performance return on investment (ROI) – period.

If you own your own stocks, you are in control. With a (MF) there is: no control over which securities fund managers buy and sell, no purchases of one particular type of stock to balance out a portfolio and no opt-out of any particular asset class or company.

On the other hand, if you put yourself in a separate account, you are the boss. Having a separate account means you are in charge. You set the strategy and decide what stocks or bonds make up the portfolio. You also have access to top money managers and can even change a manager if you wish.

The mix-and-match of separately managed accounts (SMAs) makes them attractive to the new breed of investor who wants more control and input into their portfolio. Don’t you want more control after the Madoff escapade and the Wall Street blowup?

With mutual funds, you should be advised early that you do not own the stocks in the portfolio, but merely have shares of stocks along with a large pool of people. So what do you give up when investing in mutual funds? Control.

The individual who controls the (MF) is the fund manager. Too often, this manager is tasked with dozens or even hundreds of stocks residing in one fund. This is exactly the situation in many of the 8,000 or more funds out there on the market – span, or lack of control.

In addition, you are tied to the whims of fund managers, who are often known to depend on “style drift” (buying securities that have no relationship to fund objectives), excessive trading (to pump up a fund’s value as a means of boosting commissions), and other nefarious actions – first uncovered by the Attorney General of New York State in 1993 and reoccurring ever since.

The MF companies are good at cloaking information and spinning their marketing pitches to prevent investors from figuring out exactly what they are paying to own such a fund.

Space limits us to expand on all the fees you pay for the privilege of owning mutual funds, but management fees, distribution or service fees (12b-1), expense ratios, trading costs, commissions, purchase fees, exchange fees, load charges (load funds), account fees, custodial expenses, and so on, are a part of the mix that the mutual fund companies utilize to nickel and dime you to death without most of them ever knowing the billing score.

The SEC wants every investor to be fully equipped to make informed decisions before they hand over their hard-earned cash. The SEC requires all corporations to disclose any and all information impacting their financial positions so investors can make prudent decisions. Transparency is most important due to the recurring events of the last 18 months.

MF companies provide notoriously slow reporting. It’s most difficult to find out about all the real nuts and bolts (specific equities, bonds, or cash holdings) of the fund. A (MF) gives you data twice annually – sometimes quarterly – so the data is out-of-date long before you receive it. Most investors do not read their prospectus reports and fund companies know this fact. Even with the introduction of the Internet, which has sped up the tracking for securities immensely, the major fund companies have been painfully slow to keep investors current as to what stocks the investors hold, and if and when those stocks are being traded.

Nowhere is the lack of transparency more apparent among fund companies than in costs and fees. Most investors are aware of management fees and commissions, but other fund fees like the 12b-1 and trading fees are sublimated. Other fees are hidden and, therefore, keep investors completely in the dark as to what they are paying.

With companies being so slow on reporting fund results; the investor seldom knows in real time what stocks are in his account and companies are known to hype performance results.

Unless Congress steps up and puts mutual funds on a level playing field with other investment strategies, taxable fund investors will have to fend for themselves.

The Problem With Offshore Banks

“What’s the best way to rob a bank? Start one.”

Many people have heard that old saw. But it’s no longer accurate. The best way to rob a bank is to control a government… any old government will do these days.

It wasn’t always like that. You see, for most of modern history, governments knew to keep their hands off banks. Whether led by kings, prime ministers, presidents or dictators, states understood that the first time they raided a private bank for loot would be the last. Bankers would close up shop and go somewhere else, and the next time the rulers needed to borrow some cash, there would be no lenders left in town.

My, how times have changed! Not only do modern governments feel perfectly free to steal from local banks or from offshore banks… they actively compete with each other to do so.

Guilty as Not Charged

It’s more important than ever to be choosy when picking an offshore bank.

A few weeks ago, the government of Honduras seized the property of one of the country’s leading businessmen – including the bank his family owned. The bank was liquidated, leaving over 200,000 local and foreign clients in the lurch.

Seizures and forced liquidations aren’t uncommon, of course. Courts all over the world order such things all the time when individuals or organizations are convicted of crimes. What made the Honduran case unusual is that there was no court, no trial and no crime.

You see, a relative of the Honduran businessman in question had been arrested in the U.S., where extrajudicial asset forfeiture is practiced.

In the Land of the Free, federal, state and local authorities can and do seize all sorts of property on just about any pretext, simply by asserting that the property (a car, a house, a farm, cash, etc.) is somehow associated with a crime. They don’t have to prove this – their own say-so is all they need. The owner of the seized property doesn’t have to be guilty of anything, or even be charged with a crime. Instead, he or she has to prove that the property isn’t “guilty.” Most of these owners never manage to come up with the money, time or other resources needed to do so. So they lose their property, which is usually sold for profit or used by the government.

Get While the Gettin’s Good

Knowing this, the Honduran government reasoned that it was likely that property in the U.S. belonging to the Honduran businessman’s family would be seized by the U.S. authorities. They concluded that if this happened, the businessman’s local bank might not be able to meet its commitments, angering a lot of local depositors who are also voters (or government officials).

So to get a jump on the process, so to speak, the Honduran government seized the bank before the U.S. government could get their hands on related property. It was a preemptive raid, not based on any proven violation of Honduran or U.S. law, but rather on the knowledge that if they didn’t act first, the Yankees would. It’s like a scene in a Western movie where one set of robbers races another to catch up with the stagecoach.

You might think this is a sui generis case, shaped by the U.S.’ peculiar asset forfeiture practices. Maybe so… but the underlying logic behind Honduras’ action has recently been globalized.

One Global Tax System, But Many Governments

Here’s why: The G-20 recently adopted a global financial-information-exchange protocol, inspired by the U.S.’ Foreign Account Tax Compliance Act (FATCA). Over the next few years, financial institutions everywhere will be sucked into a web of reporting designed to ensure that nobody can keep money secret from any government. Whether they like it or not, banks will have to hand over client information to their own governments, who will then share it with others.

It’s easy to see how that will make tax enforcement easier. But it may also result in some nasty unintended consequences along the lines of the Honduras case.

If the G-20 data-sharing plan works as planned, government officials everywhere will be able to monitor changes in the offshore financial holdings of local individuals or businesses. This sort of intelligence could trigger precisely the sort of preemptive strikes that took place in Honduras. A big local business is losing money in its overseas operations? Better grab its local assets now, before a foreign court can seize them as part of a bankruptcy proceeding. Ditto for individuals.

The bottom line here is that, as always, government action – the G-20 reporting web – will create a new set of incentives that will have unpredictable consequences. The only thing we can be sure of is that government will look after its interests… not yours.

The world of offshore banks is becoming more complex. That’s why it is absolutely critical that you have an inside guide to the most recent developments… so you can stay one step ahead of the government thieves.

This Is How Mutual Funds Work – Did You Know This?

Want to save for a rainy day and don’t know where to keep the extra money? Though investment avenues are multifarious, but more versatile are the reasons for which a person plans to save. Some want to just keep aside a portion of money and use it in the future when a big corpus is created (which is nothing more than sum total of amount saved every year), while others want their money to return to them after increasing.

Age old habit of keeping money in savings account in banks has somewhat lost many of its takers; reasons are many to quote. Interest rates have slashed down in recent times, one of the most popular reasons to begin with. In addition to these, newer investment options have popped up in recent times and performed beyond expectations. So, investing in mutual fund has proved to be an enticing option for those investors who are profit-oriented in thinking, and who doesn’t want extra money.

If you observe closely, people have been saving since times immemorial. Mutual fund companies have just given a systematic garb to the people’s savings habits. When mutual funds were not around, a group of people used to pool together a specific amount from each member, and by the way of lottery they used to declare the beneficiary of the collected money for the month. (This system is still functional at informal level!)

Now let’s take a look at the mutual funds that are somewhat analogous to this practice of pooling money. Companies dealing in mutual funds not only collect money from the investors, but also look for premises such as stocks of the companies, debt instruments, and other assets that are considered profit-yielding options. Money invested by the individual investors and pooled together by the fund managers is used for – infrastructural developments, to carry out an ambitious infrastructural project of a company or for bringing some technological innovation – that is of great use to the inhabitants of the country. All these reasons give way to the possibility of earning returns from the money that investors give to their fund managers, from savings point of view.

Investment made in mutual funds grows due to power of compounding and averaging of return-cost ratio. By giving your money to the fund manager to invest, you are handing him over the responsibility of managing your corpus. Thus, he re-invests returns made by your money at a constant rate every year and other returns generated in the form of interest, dividends etc. also keep appending. That is why, there is an appreciable increase registered in the amount you invested at the end of the investment period. This is the main principle behind the working of a mutual fund.

Past performance figures reveal that investors putting their trust in mutual fund investments were able to earn 15-20% returns, on an average. At times, it has grown to as high as 30-40% too. Since there is an intelligent mix of market-oriented and debt-based options in a typical mutual fund, the risk also is comparatively less, as compared to pure equity-based instruments like, stocks.

Thus, by savings in mutual funds, an investor meets a variety of purposes:

1. He is able to earn extra from his own savings
2. He is indirectly contributing to the economic development of the country
3. He is creating extra income for himself to meet the unforeseen expenses
4. And last but not the least, he is securing his future too.

Costs involved in investing in mutual funds comprise of transaction costs, asset management cost, holding fees and other implied taxes. Thus, the amount that is actually invested is your money minus all the taxes. Mutual funds perform in spite of all these costs, such is the power of compounding. To make more out of your money, it is advisable to keep the money for the long term. So, if you are looking for the investment option that is yielding like a stock but safer than it, then mutual funds prove to be the smartest choice.