1. Global Financial Private Capital, is an SEC registered investment adviser principally located in Sarasota, Florida. Investment Advisory Services offered on a fee basis
through Global Financial Private Capital, LLC. Securities offered through GF Investment Services, LLC, Member FINRA/SIPC.
2080 Ringling Boulevard, Sarasota, Florida 34237 • Tel: (866) 641-2186 • Fax: (941) 918-0405 • www.gf-pc.com • info@gf-pc.com
SYNOPSIS
• Mutual funds are riddled with unfavorable
tax rules, and their inefficiencies are one
of the many reasons that the Investment
Committee chooses to avoid using them for
our strategies.
• Two examples of these inefficiencies involve
deducting losses and realizing capital gains
on trades within mutual funds.
• The Investment Committee strongly urges
investors to reconsider the use of mutual
funds given their propensity to frustrate
their holders around tax time every year.
A Deeper Dive Into Mutual Fund Tax Issues
THOUGHT FOR THE WEEK
A FEW EXAMPLES OF TAX INEFFICIENCY
Last week, the Investment Committee discussed the
performance of mutual funds vs. the stocks of the
companies that manage the funds. During our
explanation of why the company’s stocks tend to
massively outperform the funds they manage, we
also hinted to the many tax issues that plague
these products.
This claim quickly prompted many of our readers
to reach out to the Investment Committee to better
understand why we they are so tax inefficient. Therefore,
we will walk through two examples this week, which dig
deeper into the key tax problems with mutual funds to
better explain one of the many reasons why we do not
use them in our investment strategies.
The first explains the inability to use capital losses to
offset gains, and the second involves unanticipated
tax obligations that happen more frequently than most
investors may realize.
CAPITAL LOSSES DON’T TRANSFER
Let’s begin by assuming that an investor were to
purchase 100 shares of Apple at $100/share for
$10,000 total, and then a few months later, the
stock price falls to $70. After researching the reason
for the price decline, she decides that her original
thesis was likely incorrect and subsequently chooses
to sell all of her Apple stock. Therefore, she would
have a loss of $3,000 from this investment ($7,000
- $10,000 = -$3,000).
Here, the U.S. tax code would actually allow her to
deduct an amount, up to $3,000 annually, from her
gains in a given year. Therefore, if she ended the year
with $25,000 in gains from the rest of her portfolio, she
could reduce her tax liability to $22,000 ($25,000 -
$3,000 = $22,000).
NOTE: One of the very few nice features in the U.S. tax
code allows our investor to carry this loss into future
years if she had no gains during the current year. For
example, if she had a $10,000 net loss for the year
instead of a $25,000 gain, she could use that $3,000
against any gains next year.
However, mutual fund taxes work quite differently. Let’s
say that our investor bought a mutual fund, and that
mutual fund bought Apple at $100 and sold at $70
for a loss. Since the investor owns shares of the mutual
fund and not the stock, she will not be allowed to
deduct the loss.
Simply put, if your mutual fund has a loss in a
specific stock, you do NOT get to deduct the loss on
your tax return!
2. Global Financial Private Capital, is an SEC registered investment adviser principally located in Sarasota, Florida. Investment Advisory Services offered on a fee basis
through Global Financial Private Capital, LLC. Securities offered through GF Investment Services, LLC, Member FINRA/SIPC.
2080 Ringling Boulevard, Sarasota, Florida 34237 • Tel: (866) 641-2186 • Fax: (941) 918-0405 • www.gf-pc.com • info@gf-pc.com
THOUGHT FOR THE WEEK
TAXES ON FUND RETURNS
Now let’s dig into what happens when a mutual fund
manager sells a stock for a gain. If a manager were
to buy Apple at $100/share and then sell for $130/
share, U.S. law would require the fund to distribute
those gains to all shareholders at the end of every year
and are taxed accordingly.
Hence, you cannot take the individual losses (as
explained above), and you get taxed based on the
gains of the fund, which you did not create!
This concept is a little tricky so here’s a hypothetical
example. Suppose a mutual fund bought IBM stock at
$100/share back in 2003, and a few more years into a
rising equity market an investor chose to buy shares of
the mutual fund in 2007.
At some point the market begins to fall, and the fund
manager (not you) decides that IBM is no longer a good
investment and sells the stock at $130/share. The
chart below depicts the timeline of these events.
The mutual fund has made a profit of $30/share ($130
- $100), however, the investor never really gained
anything because he bought into the mutual fund when
IBM’s stock was above $150. In fact, he technically
lost money on this individual stock within the fund.
Here is where mutual fund taxes become comical. The
investor still has to pay his share of the gains tax on
the mutual fund capital gain, even though his mutual
fund investment potentially lost money!
NOTE: Although this is a fictional example, this very
circumstance happened to millions of mutual fund
investors during the financial crisis in 2008. Fund
managers received so many redemptions that they
had to sell stocks to raise cash. Subsequently,
many investors remaining in funds were then
forced to pay unexpected taxes at the end of an
already difficult year.
3. Global Financial Private Capital, is an SEC registered investment adviser principally located in Sarasota, Florida. Investment Advisory Services offered on a fee basis
through Global Financial Private Capital, LLC. Securities offered through GF Investment Services, LLC, Member FINRA/SIPC.
2080 Ringling Boulevard, Sarasota, Florida 34237 • Tel: (866) 641-2186 • Fax: (941) 918-0405 • www.gf-pc.com • info@gf-pc.com
THOUGHT FOR THE WEEK
Sincerely,
Mike Sorrentino, CFA
Chief Strategist,
Aviance Capital Management
This commentary is not intended as investment advice or an investment recommendation. It is solely the
opinion of our investment managers at the time of writing. Nothing in the commentary should be construed as a
solicitation to buy or sell securities. Past performance is no indication of future performance. Liquid securities,
such as those held within DIAS portfolios, can fall in value. Global Financial Private Capital is an SEC Registered
Investment Adviser.
Simply put, mutual fund investors pay capital gains taxes
each year that there are trades within the fund, despite
any action from the investor. Therefore, even if an investor
makes no trades in a given year in his portfolio, he still
likely has to pay taxes if the fund manager traded within
the mutual fund.
IMPLICATIONS FOR INVESTORS
Institutional investors are generally labeled as those who
have $500 million+ in investible assets, and this highly
sophisticated group would almost never allow themselves
to be subjected to tax implications out of their control.
Since Global Financial Private Capital manages money
for both institutional and retail investors, we do not use
mutual funds in any part of our investment process.
Rather, we are able to offer all investors the same level
of attention and resources, irrespective of the size of
investible assets.
The bottom line is that the tax issues of mutual funds
are real and adversely impact an overwhelmingly large
number of investors every year. Mutual funds had
their time, but they are now obsolete in the face of the
products that we use to manage our client’s accounts.
