Each year at around this season, many mutual-fund investors and financial advisers turn shy -- and stop investing.
"Generally, we don't invest new money from our clients after Nov. 1," says Louis Stanasolovich, a financial planner in Pittsburgh. "You have to be very cautious at this time of year."At least in theory. Dec. 1 marks the date after which most mutual funds begin to pay out their capital-gains distributions. These distributions can sock investors, even new ones who just recently bought into a fund, with a troublesome capital-gains tax. To avoid the tax burden, advisers generally recommend purchasing mutual funds again only after the new year.
Trouble is, waiting to invest in a mutual fund until after its distribution has been paid out poses several dangers. For one, there can be what is known as an opportunity cost. While waiting to invest, the stock market may rise. A rise might negate the savings in tax that you were trying to make by not investing earlier.
"For stock funds especially, there is a risk in being out of the market," warns Bob Bingham, a financial adviser at Bingham, Osborn & Scarborough, San Francisco. "The markets historically can make large gains in short periods of time."
For another, waiting until after Jan. 1 to buy a fund doesn't mean you don't have to pay any capital-gains tax whatsoever. Ultimately, an investor will have to fork over taxes on any fund they hold within their own portfolio. By waiting to purchase the fund, the tax simply is deferred.
"At some point, you're going to have to pay the tax," says Sheldon Jacobs, editor of the No-Load Fund Investor, a newsletter in Irvington, N.Y. "We make too big a deal of these capital-gains distributions" and how it affects our purchasing patterns.
Of course, investors shouldn't plunge willy-nilly into new funds at year end either. Mr. Jacobs estimates that the average fund distribution this year will range from 6 percent to 7 percent. This can translate into a substantial tax burden for some investors, especially if the market heads south again, and they don't recoup the cost of paying the tax with a commensurate gain in the fund.
To help decide whether to buy a new fund at this time of year, several conservative steps should be considered:
Load up on information: Morningstar Inc., the Chicago fund-research firm, publishes a range of data on fund portfolios, including whether the fund has huge embedded gains. From this information, investors can figure out how large a distribution the fund is likely to pay out this year.
Even better, dial the fund companies' toll-free numbers and ask them directly what capital-gains distributions their funds likely will pay out. In the past few years, fund firms have been increasingly willing to divulge this information. T. Rowe Price Associates and Vanguard Group, for instance, post such information on the Internet. The firms also send out fliers and newsletters containing the distribution data.
"I would try and seek out funds that aren't planning large distributions," says David Drucker, a financial planner in Albuquerque, N.M. "And I'd try and get the information directly from the horse's mouth. Don't rely on third-party material too much."
Take the plunge: It may be less taxing to buy funds at the end of this year. Because of the market jitters in 1998's third quarter, many funds lost, rather than gained, in performance. That means they are likely to pay out little to no capital-gains distributions. Some categories of funds that fit this bill include real-estate funds and small-capitalization stock funds, both of which have performed poorly this year, says Stanasolovich, the Pittsburgh financial adviser.
Investors might also consider buying into a hefty number of funds that already have paid out distributions this year. A partial list includes Oakmark Fund, Oakmark Small Cap Fund, Fidelity Blue Chip Growth Fund and Fidelity Growth & Income Fund.
Stick with history: An individual can search for funds that traditionally pay out lower capital-gains distributions -- for instance, index funds. Charles Schwab Corp.'s Schwab 1000 Fund and Schwab S&P 500 Index Fund both haven't paid out any capital-gains distributions since their inception, according to Schwab spokesman Greg Gable.
Think IRA: Investors with an individual retirement account may consider buying a fund now for their IRA instead of for their own taxable portfolio. The IRA is tax deferred, so investors can duck the consequences of a capital-gains distribution for a while.
Here's how a typical maneuver might work: Say, for instance, you find a stock fund you want to buy. To avoid the fund's distribution, you sell a bond fund from your IRA. Using money from that sale, you buy the stock fund you were considering for your IRA. Then you can buy the bond fund that you just sold back for your own taxable portfolio, since bond funds don't pay out huge distributions. That way, your asset-allocation plans won't be greatly disturbed.
"You'd end up with the same portfolio position, virtually," says Mr. Bingham, the San Francisco financial planner. "It's just a double switch."
Mark Riepe, vice president at Charles Schwab's Center for Investment Research, says most investors should generally invest immediately, whether there are tax consequences or not. In a recent study, he notes that market timing is impossible to perfect. More important, he says, "procrastination may be much worse than bad timing."