How to let others influence your investment income this year

joyfulguyJune 1, 2008

Suppose you own some equity-based mutual funds.

As the stock market has suffered some reduced prices of stocks in recent months, you felt that the price drop was temporary but that the values were still there, so stayed fully invested.

Some of the other mutual fund holders, worried, have been chewing finger nails for a while, till they got them chewed down, then started trying to reach their toenails ... unsuccessfully.

Not wanting to bloody their fingers by continued chewing ...

... they instructed the managers to sign them out, at least partially, but some pulled out totally.

In the early days of such requests, the mutual fund managers had paid some out with cash on hand, but then had to sell some of their holdings in order to pay out the folks who were leaving, scared.

Which resulted in some capital gains. The payouts were made to the leavers relative to the value of the assets at the time of their withdrawal - so they get the benefit of the increased value of the assets.

Did some of those capital gains show up on their report for income tax purposes? No - they won't be accounted for till later in the year. Those guys will have been long gone by then.

But ... those capital gains will show up as credited to your account, when the year's accounts are made up.

Which you will have to show on this year's income tax return when you prepare it, next spring.

Did you make any change in your account?


Do you have to declare income (some of which was carried away, with no tax liability declared, by earlier leavers) none the less?

Sure do.

As the market falls farther, more stocks will be sold at closer to purchase price in order to redeem for more investors, so next to no effect on your year-end report of income.

If the market falls some more ... stocks will be sold below the purchase price ... so how do you like other investors forcing the sale of valuable assets at an unwise time?

However ... the losses will tend to cancel out the profits registered before the market had gone down so far. Meaning that you'll have less capital gain that you'll be required to report, next spring. But - how do you like others forcing the sale of some of your (and their) assets at fire-sale prices?

Too bad more mutual funds haven't as part of their guidelines the opportunity to borrow to pay out their holders when markets are undervalued, but few have given themselves that option.

Probably with some wisdom, for that option would scare the pants/panties off of a number of potential investors, who'd fear that it would be misused.

Remember those stocks that I bought over 40 years ago for $4.20 or so?

No sales in the interim ... so no necessity to report part of the capital gain to the income tax people.

That stock was "worth" (well, could have been sold for) $106. a year ago now. Involved with those skullduggerous U.S. sub-prime mortgages, plus in a company insuring them, their value decreased to $59.00 or so, a few months ago, are about $72.00 now.

Am I selling ... to crystallize some of those capital gains (and make them taxable currently)?


I'd seen my investment double 4.5 times, earlier ... now it's doubled about 4.1 times. There'll be further recovery - I'm not about to sell now.

No reporting to the income tax people regarding that stock's capital situation, at this point.

I prefer that situation.

Good wishes for increasingly skillful management of your assets (income, as well).

ole joyful

P.S. Plus .. in many cases, you're paying the managers of the mutual funds (few of whose growth records outpace the market averages) a management fee probably rather comparable to the rate of income tax that you're paying on that income.

And the managers get paid at regular rates ... whether you get any growth/income or not!

o j

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You've just articulated one reason to own ETFs instead of conventional mutual funds: If you hold onto an ETF when other shareholders sell, you aren't taxed for their capital gains.

    Bookmark   June 1, 2008 at 10:52PM
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OTOH, capital gains taxes right now are at their lowest level in decades. Depending on who wins the presidential election in November, that rate may or may not rise in the future.

Capital gains in a retirement account aren't taxed, just for the information of any beginners checking in here. OJ is discussing taxable investment accounts.

WSJournal just published an article discussing mutual funds that have a 3-yr above average ROI, are tax advantaged, and have low fees equivalent to what many ETFs charge. ETFs are the newest "hot" market product, with more being introduced every day - and thus very little track record for market results. The newest iteration use a stock picker, which is the exact opposite of what ETFs were designed to be. Trust Wall St. to come up with new ways to put their hands in your pockets - I don't object to the idea on principle, but ETFs run by stock pickers is a concept that makes no sense to me as an investor (although plenty of sense as a brokerage!).

I'm not saying ETFs are bad - just that like any financial product, it's 'caveat emptor'. They are not automatically a "good thing" and mutual funds automatically a "bad thing".

People need 3 things to be financially successful:
1) Clearly defined goals, with the flexibility to change as your life changes occur (marriage/children/death).
2) An honest acceptance of how much risk they can tolerate and what that means to their financial returns over time
3) Realizing they do not need to know everything, but it pays to devote at least half as much time annually, to your financial health, as you do to your favorite hobby in a month's time.

    Bookmark   June 2, 2008 at 12:20PM
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After I'd bought some equity-based mutual funds, for that fabled "diversification", I decided that I didn't like the fees that I was paying to the managers - darn near as high as the income tax that I paid on on the average rate of gain (but some of the growth was deferred until I sold, of course).

By the way ... when you own mutual funds that produce capital gain, in a regular account (not one of the tax-deferred retirement account ones) you must keep track of not only what you paid in the first place, but add all of those payiouts that they reported to you from time to time, usually annually, as the years went along, as they were reinvested.

When you sell, your "cost" (for calculating capital gain) wasn't just the amount of your original investment, but included all of those distributions, that were reinvested.

If you don't add those (usually annual) reinvested amounts ... you'll be paying tax on them twice - if they're outside of a tax-deferred retirement account!

I decided some time ago that I prefer to buy individual stocks myself.

On some of the stocks that I own, I used to be taxed at a low rate on dividends, and that rate was reduced even farther, recently.

If I earn those dividends in a tax-deferred retirement account, I have no tax liability on the dividends currently, an advantage. But ... when I cash out, I pay tax at regular rate on every dollar ... so I lose the tax advantage that I would currently enjoy if they were taxable now.

When I borrow to invest, for solid stocks, aiming at the long term - to fund that retirement - I use the current dividends that the stocks bought with the borrowed funds produce, plus some of the ones earned by the shares that I'd bought with my cash, to pay the interest on the loan ... and that interest is deductible. So I end up paying next to no tax on those dividends, or even gain a bit.

When I take money our of my retirement account - taxed on every dollar, at full rate.

When I sell some of my regular stocks (the non-tax-deferred-retirement-account ones), I deduct the amount that I invested originally (plus the reinvested dividends, if I have been using a dividend-reinvestment plan) anddeduct that from the amount of the proceeds of sale to find tha capital gain.

I pay at regular rate on half of that capital gain ... but I get half of it free of tax.

It makes sense, in this country, to keep bonds, GICs, etc. where the number of dollars originally invested won't grow, and the regular earnings are interest, that's taxed at top rate, in those tax-deferred retirement avccounts. Not equities, and certainly not Canadian equities.

I'm nearing 80 years of age, and I have about 80% of my assets in equity-based investments ... and that suits me well.

Good wishes to you for increasingly wise use of your income ... plus assets.

ole joyful

    Bookmark   June 2, 2008 at 6:36PM
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There are different methods to determine cost basis when it comes to the taxing of liquidated stock assets. Below is a link to an old, but good basic accounting posting from the CPA Journal that discusses this in a bit more detail. The US short-term capital gains tax is higher than the long-term (one year) cap gains tax.

Here is a link that might be useful: Potential tax problems when liquidating mutual fund shares

    Bookmark   June 2, 2008 at 8:29PM
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