Mutual funds are pooled investments that allow investors to diversify their portfolios and benefit from professional management. They are a great choice for workplace retirement plans and IRAs. But they are less than ideal for non-retirement brokerage accounts for two reasons:
Tax inefficiency: Mutual funds are subject to capital gains taxes whenever they sell securities within the fund, regardless of whether the investors sell their shares or not. This means that investors utilizing brokerage accounts may have to pay taxes on gains that they did not realize or benefit from. Moreover, mutual funds distribute their capital gains and dividends to their shareholders at least once a year, which may trigger additional tax liabilities for the investors. Investors who choose to sell securities during the year may also trigger taxes. This isn’t something investors utilizing retirement plans need to worry about as all gains are taxed as income at distribution only.
Poor trade execution: Mutual funds trade only once a day at the end of the market. This means that investors cannot take advantage of intraday price movements or place limits or stop orders to protect their positions. Moreover, mutual funds may face liquidity issues if they must sell large amounts of securities in a declining market to meet redemption requests from their shareholders. If your goal is long-term for retirement, this lack of control isn’t a problem, but if you’re investing through a brokerage account for the benefits of flexibility and control over timing of transactions, you may be better off using ETFs, stocks, bonds, etc. It’s important to note that we are not suggesting that you sell mutual funds you already own in your brokerage account as that triggers capital gains taxes. But you may benefit from future purchases in these other options to provide you with more flexibility.
If this seems overwhelming to you, don’t worry, you’re in good company as most people feel the same way. We can help. Your employer has engaged the Financial Planning team at Francis LLC to provide confidential money coaching on any money matter, including investment advice, without any hidden sales angles. Visit us online or download the free Francis LLC app today to schedule an appointment with a Financial Planner.