to taxes, they don’t threaten investors with a ‘tax overhang.’” For example, if a fund created a decade ago has been tremendously successful in investing in the likes of Microsoft (Nasdaq: MSFT), Intel (Nasdaq: INTC) and Cisco Systems (Nasdaq: CSCO), you may decide to scoop up shares. The next week, however, that same fund decides to unload all its tech-stock winners and move into utilities. When the fund sells its stocks, all its “realized capital gains” will be passed on to investors, even newcomers. That means you’ll owe tax on those gains, even though you didn’t fully enjoy them. “Young funds don’t pose this problem,” says Dziubinski, “so they may be especially suitable for holding in taxable accounts rather than tax-deferred retirement plans.”
Some rookies offer lower costs-especially index funds. Byron Snearl of Los Angeles counts himself among those who have found the advantages of such vehicles. “I don’t have the time to study the funds closely,” says the retiree who now manages his own rental properties, “so I invest through index funds. They mimic the market and I’ll settle for those kinds of returns. They’re low-cost, tax-efficient and don’t present the risks of picking the wrong fund manager.”
The bargain-hunting Snearl, of course, prefers “no-load” funds-those without sales charges-because they tend to offer solid returns at cheap prices. His preference: low-cost index funds from Vanguard Group. “I use dollar-cost-averaging to lower my risks even more,” he says, investing $400 each month, which gives him the opportunity to buy more shares when prices drop.
ASKING THE RIGHT QUESTIONS
Despite the advantages, these newcomers can be a tad risky. If you can’t examine a track record going back several years, it’s hard to know exactly what you’re buying. So that you don’t get stuck, Morningstar suggests that you ask these four questions before buying a new fund:
Has the manager run a mutual fund before? If not, does the sponsoring fund family have a strong track record and clear approach? The managers of the 12 funds that Morningstar selected generally have had prior experience running mutual funds. Only one was an exception.
Gale McEvilley, a financial planner with Rinehart & Associates in Charlotte, North Carolina, believes that nothing beats an old hand who has been successful in racking up returns.”If it’s an experienced manager and the fund is the same type that the manager has run successfully in the past, a new fund may be worth considering,” she says.
Does the manager have a clearly articulated strategy, and is it reflected in the current portfolio? Some funds will hold dozens of stocks while others stockpile hundreds. Some invest in name-brand companies while others will gamble on unknowns. By examining a fund’s current holdings and reading the prospectus, you’ll have a better idea of its investment philosophy and future direction.
Investors like Dr. Derek Lewis, a family physician in Little Rock, Arkansas, seek new funds that fit their aggressive bent. “I won’t be retiring for at least 15 years, so I’m comfortable taking risks, ” he says. “Generally, I buy