---D.P., by e-mail
A. No, short-term bond funds would not be OK. They should not be used for day-to-day payments because their net asset value per share fluctuates from day-to-day. While the fluctuations are small, accounting for them on a tax return can be time consuming. Basically, you would have a slew of minor transactions showing small gains or losses.
If you draw income from your investments you should organize your accounts so that all your investment accounts feed a checking account used for bill payments. You could, for instance, have a multi-fund account and have all your investment fund income automatically paid into a money market fund. If the income isn't sufficient to pay all bills, you could plan to make a single redemption from a fund every three months and transfer the redemption cash to your money market fund.
This way you have minimal transactions for your capital gains and losses report. In the current interest rate environment, virtually no interest income will be lost.
Q. My wife is the unhappy owner of a mutual fund that is not in a 401k plan. It's Brandywine Fund. Their disastrous performance this past year resulted in her receiving $21,639 in reportable income on a net asset value of $52,000. This resulted in an income tax due of about $6,000 plus penalties. I had not anticipated this, especially when she was suffering an overall loss on the fund.
How can we avoid this in the year to come? The funds' customer service staff cannot provide information on this. I have tried. What would you anticipate occurring over the balance of the year in reportable income dividends and capital gains?
Also, if she sells before the distribution date, which I think is in October, will she avoid this? Income and capital gains that have been reported over the past several years combined with her purchase price far exceed the funds net asset value.
I have 12 other mutual funds that are not in a 401k plan, primarily Vanguard, which have not had this severe a problem. Are they likely to do the same thing in 2001 as Brandywine did in 2000?
---B.B., by e-mail
A. Complain about the taxes if you must, but don't complain too much about the performance of Brandywine fund. In 8 of the last 10 years this mid-cap growth fund has beaten its benchmark, the Russell Mid-Cap Growth Index. It has also beaten the S&P 500 in 6 of the last 10 years. It beat both indices in 1999 and 2000 and it has done better than 80 percent of its competitors over the last year and 3 years.
Let me put this in some perspective for you. Suppose you had invested $25,000 each in Brandywine and Vanguard 500 Index fund three years ago. By the end of March 2001 your investment in the Vanguard 500 Index fund would have been worth $28,769 and you would have received very little in taxable distributions. Indeed, Morningstar Principia Portfolio Planner shows only $1,136 in dividend distributions and $369 in capital gain distributions during the entire three-year period.
The same investment in Brandywine would be different. Your original investment would be worth some $34,486 and the fund would have distributed $0 in taxable dividends. You would, however, have received a taxable capital gain dividend of $14,045 last October and you would owe just over $2,800 in capital gains taxes.
Annoying, to be sure, but as I see it you made a good selection and you're still ahead. At the quarter end, according to the Morningstar database, Brandywine had an unrealized capital loss of 14 percent while Vanguard 500 Index fund had unrealized capital gains equal to 29 percent of net asset value. So you're not likely to get a capital gain distribution from Brandywine this year--- but investors could get one from Vanguard 500 Index.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
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