(888) 4-ALMEGA info@almega-wealth.com

One of the challenges of owning actively managed mutual funds comes when the mutual fund has unexplained poor performance and you resultantly want to sell the fund to replace it. Thus you have to evaluate your actively managed mutual funds versus embedded capital gains. This can create a tax consequence, especially if you’ve held the fund for a long period of time and the fund has historically done well.

First, let’s quickly understand what an actively managed mutual fund is. An actively managed mutual fund is a mutual fund whereby the fund company is picking stocks they think will outperform. This differs from an index fund, like the Vanguard 500 fund which tracks the S&P 500 Index, or a passive fund, like the Dimensional US Core Fund which basically buys every publicly traded stock in the United States. The company which runs the actively managed mutual fund thinks they have skill, knowledge, or a proprietary method which will give their fund a leg up.

So what happens when the actively managed mutual fund doesn’t do well and loses a significant amount more than an Index Fund or a Passive Fund? Most people will want to replace the poor performer — it’s human nature. The problem comes when you hold that actively managed mutual fund in a taxable investment account and you must then realize capital gains on the positive performance of the fund over the years and years you’ve held it. This creates inefficiencies which can be avoided by instead using an Index Fund or a Passive Fund which will never have unexplained poor performance.

To avoid having to make the hard decision of pitting future performance against embedded capital gains we at Almega Wealth Management use Index Funds, or more often Passive Funds like those from Dimensional, in client portfolios. To learn more about Almega Wealth Management’s investment philosophies please click here or schedule a Discovery Meeting.