The Herald Bulletin

Morning Update

Local Business

June 15, 2013

'Big Joe' Clark: Taxed today and gone tomorrow

Volatile markets lead to ulcers, hyper tension and nervous reactions as well as a good dose of excitement. Fear and greed tend to drive all markets and with money managers underperforming most indices it is very easy for people to forget the plan and jump on to the ride. The emotional thrill of market gains is hard to deny but don't forget the IRS standing in the corner.

Large swings within the market have become more common than many of us would like. As investors see an increase in volatility their natural reaction is fear which can lead to emotional decisions within their investment accounts. The volatility caused panic by some and large withdraws by others from mutual funds. Mangers of funds often have to sell to cover the withdraw requests in order to meet the redemption requests by investors. There is much confusion regarding mutual fund taxation but you do indeed get 1099 tax forms for gains inside of mutual funds even if you didn't sell.

The gains are often referred to as phantom capital gains. You buy a fund with a $10 net asset value and you own a unit of the fund or technically the trust. People like to say that you own the underlying shares held inside the mutual fund but that is not accurate.

Let’s say you have a great manager who bought stock ABC in January for $25 a share. The market had a great run and suddenly ABC was trading at $40 per share. You jump in and make your investment in the fund in June at $10 per unit. Now let's pretend there was big market volatility after you purchased your shares. Your investment falls to $8 but you don't sell. You have a realized loss on paper but not a recognized loss since you didn't sell. Some of your fellow investors did sell and your mutual fund has to raise cash.

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