Here are three recent queries from the minds of fund investors:
I own Fidelity Magellan and read on a message board about how a lot of people are unhappy that the fund had a big capital gains payout. I thought capital gains meant I was making money. Is this really so bad?
-- Mark in Keller, Texas
In early May, Fidelity Magellan (FMAGX) paid shareholders $22.36 per share in long-term capital gains and dividends. That was 18 percent of the fund's value. Magellan shares declined by the amount of the distribution, scaring the bejeepers out of a lot of shareholders, although most investors simply reinvested the proceeds, ending up with the same dollar amount invested in the fund. They own more shares, making up for the lower price and wiping out the perceived loss.
Mutual funds are "pass-through" securities, meaning that whatever tax burdens they rack up get passed to shareholders for payment. Funds realize capital gains when they sell securities at a profit.
Gains build over time, and most funds subtract losses and make a distribution late in the year; if gains are particularly big, however, a special payment like Magellan's could be used.
Investors who hold a fund in a taxable account owe taxes on those distributions. When a fund is in a tax-advantaged account, the way most shareholders hold Magellan, distributions are simply part of the long-term growth, which gets taxed when the shares are sold, if ever.
Magellan's distribution was mostly caused by moves made by new manager Harry Lange, who took over the fund last Halloween and has been revamping it to fit his preferred management style.
About the only people suggesting the big distribution payout was bad are those who will owe taxes on it next year, plus shareholders who take distributions in cash and who now have a big wad of cash to find a home for.
Barring those conditions -- and many investors take steps to minimize those tax headaches -- distributions are nothing to get too excited or upset about.
The easiest way for a fund to avoid gains is to make no money, but big gains don't always mean a fund is great. For proof, look at Magellan itself; while racking up that enormous gain, the fund has lagged behind the Standard & Poor's 500 index for years.
Are there any fund companies that let me rebalance my fund account automatically so that when something grows big I can take profits without having to watch my funds every day?
-- Hal in Renton, Wash.
Probably not, but you shouldn't be watching your funds and waiting to pounce every day anyway.
Rebalancing is the process of harvesting winners and redeploying the money into other areas so that a portfolio stays at target allocations. It is a sound idea that fits into any buy-low, sell-high strategy.
Many firms allow systematic withdrawals, letting shareholders pull money from one fund and move it to another at regular intervals. That's not perfect for rebalancing, however, because the pullout occurs on a regular basis, rather than when a fund has gone on a hot streak and gotten to where it represents too big a chunk of the portfolio.
Another option from some firms is "cross reinvestment." This allows shareholders to take income and capital gains payouts from one fund and reinvest them in a sister fund (or in a fund offered in the same brokerage plan).
It is a bit more random than the systematic withdrawal (witness the Magellan situation), so it is hard to know whether it will be sufficient to really rebalance the portfolio.
Financial advisers frequently rebalance portfolios as part of their services, but most also caution against making changes too often.
Move the portfolio every time it has a fund that is 5 percent to 10 percent above or below its target allocation. That should not happen too often; if it does not occur on its own, rebalancing once every two years should be sufficient.
How many funds should I own? I just started investing, and I have four now.
-- Melissa in Oak Park, Ill.
Worry more about the types of funds you own than how many. The typical investor can achieve financial goals with somewhere from four to 12 firstname.lastname@example.org
Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.