Carlson critiques funds: no-load stocks vs. no-load mutual funds

Black Enterprise, Oct, 1995 by Charles B. Carlson

Frequent switching among mutual funds within the same fund family and liberal check-writing privileges for some bond funds also present potential tax problems. Being able to switch from one fund to another with just a phone call is a major advertising point of the big fund families. Worried about the stock market? No problem. Just switch your funds from an equity fund to the fund family's moneymarket fund. Want more exposure to international markets? Simply take some of your money out of that bond fund and invest in the fund family's Pacific rim fund. The problem from a tax standpoint, is that every time you switch funds, you incur a tax liability. Indeed, switching money from one fund to another is the same as selling shares in the fund and buying shares in the new fund. If you have a gain on the shares in the fund from which you are switching, you'll have to account for the gain at tax time. Thus, switching privileges are a double-edged sword for investors--more flexibility, but more tax headaches.

And those bond funds that have liberal check-writing features present another taxing problem. Investors who write checks against their holdings in a bond fund--not a money-market fund, mind you, but a bond fund--are, in effect, selling fund shares. Anytime you sell an investment that is held outside an IRA or other retirement-type account, you incur a potential tax liability. To illustrate the problem, I once knew an investor who was writing checks against his bond fund for everything--groceries, gifts, you name it. You can imagine his shock when he learned that each time he wrote a check against his bond fund, he had to account for the transaction to the IRS.

From an NLS Perspective. Fund investors are at the mercy of fund managers when it comes to incurring an unwanted tax liability. The fund managers decide when and how much realized gains to distribute. Fund managers also determine what types of stocks to purchase-high dividend-paying stocks to which create additional tax liabilities for fund holders, or low-dividend-paying stocks. The fact is that fund managers don't necessarily manage the fund based on tax considerations. That's because mutual funds don't pay taxes--you do. Furthermore, the generous switching and checkwriting features have tax consequences as well. However, with no-load stocks, you control your tax destiny. You decide when to realize capital gains. You decide if you want to invest in high-dividend-paying stocks--and incur the tax liability for dividend income--or low-paying or no-paying dividend stocks. You decide when to offset capital gains by taking losses. In short, no-load stock investors control when and how much to pay in taxes on their investments. This control, which is not available in mutual funds, can have huge implications in terms of after-tax investment returns over time.

Excerpted from No-load Stocks: How to Buy Your First Share and Every Share Directly from the Company--With No Broker's Fee by Charles B. Carlson copyright [C] 1995, McGraw, Hill Inc. Reprinted by permission of the publisher.