Tax Planning Ideas - Avoid Mutual Funds in Investment Accounts
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Mutual Funds Are Great in Your IRA’s and 401K’s but Not in Investment Accounts
CHAMBERS: Hey, everybody. This is Trevor Chambers from Olde Raleigh Financial Group in, currently a little overcast Raleigh day. And I have -- I have with me a really special guest today.
MIHAJLOV: Very special.
CHAMBERS: Mr. Alex, I just want to say, your deep voice today just sounds fabulous.
MIHAJLOV: Yes.
WHY DO ADVISORS PUT MUTUAL FUNDS INTO TAXABLE ACCOUNTS?
CHAMBERS: Okay. In all seriousness, we want to talk about something. Alex, one of your pet peeves, I've worked with you now for going on seven years. And one of the things that I've learned from you is a little pet peeve, a thing called mutual funds in taxable accounts. Now let's talk about mutual funds for a second. What is it? What are some pros? What are some cons? And then what's our problem with finding mutual funds in taxable accounts.
MIHAJLOV: Good morning, Trevor. It's always good --
CHAMBERS: Alex, we haven't done this in a long time.
MIHAJLOV: -- to see you. It's always good to be with you, even though we're next-door neighbors in the office. We don't -- we talk much to seldom.
CHAMBERS: Let's just start there.
MIHAJLOV: Let's talk about mutual funds. Let's talk about what's going on. Everybody's calling in and going, I paid a lot in taxes last year, paid a lot in taxes. My capital gains were high and while last year was a great year for capital gains. There are some capital gains that are controllable. One of those ways is controlling what mutual funds and why you would own a mutual fund in a taxable account.
CHAMBERS: Right.
MIHAJLOV: Let's talk about what's good about mutual funds.
CHAMBERS: Well, what’s a mutual fund?
MIHAJLOV: Basically, a mutual fund lets your investor, every investor be -- have the advantages of being a big investor while being a small investor. They get diversification basically at every dollar level. The investment expenses are spread out over the whole pool of the mutual fund. You get the, you know, the economies of scale and operational efficiencies of having a big pool of money. You can certainly invest in specialized sectors and areas through mutual funds. They are easily accessible and tracked. It is simplified portfolio management. It is easy to switch among mutual funds in a family. You know, it does give you access to professional money managers. And certainly, the trading costs involved in mutual funds tend to be lower than the individual trading costs on buying individual stocks, et cetera. So that's kind of gone away as well.
CHAMBERS: And it's really helped so many people who -- to access the market, right? I mean, it's been -- nothing wrong with mutual funds. That's not what we're saying.
MIHAJLOV: It's a great diversification tool for someone that’s starting out.
CHAMBERS: However.
MIHAJLOV: However, what I'm seeing a lot of from my competition is people are buying mutual funds in their taxable accounts. And what's wrong with that? Well, the problem with owning a mutual fund in a taxable account is come every November and December, and sometimes in the middle of the year, if they're having a really good year, they tally up they're winners versus losers in their portfolio and they cash out. They might cash out a winner. And what they -- what that winner does is creates a capital gain for you that you really had no idea about and no control over. And it might've been a stock that they've held for 20 years and you've had the fun for three weeks. So, it's not controllable by you. So, I really am not wild about mutual funds in taxable accounts. And I think it's, you know, one of our friendly CPAs sent me a statement on another client's account at another firm where they just had a slew of capital gains fall out of their mutual funds in their taxable accounts, despite this gentleman making a whole lot of money and really needing to control their capital gains.
CHAMBERS: So why would an advisor here in Raleigh or in the triangle, put somebody -- take a taxable account and put a mutual fund in it? And why would they do that?
MIHAJLOV: Probably because they either don't know or are not confident in what the alternatives are to that type of process. You can still invest and you can still invest in equities in taxable accounts. I just think there's much more tax efficient ways of doing that.
CHAMBERS: All right. So, let's get into that. Like, ETF, singled --
MIHAJLOV: You know, there's two other primary ways you can certainly buy individual stocks or have a pool of managed individual stocks and you can also use exchange traded funds, which basically you really don't create capital gains unless the fund is bought or sold, which you are in control of. So that -- I think those are two avenues that make a lot more sense for people in taxable accounts. Now, when you're inside an IRA or some other qualified plan, this argument certainly goes away. But in an account that I'm paying tax on every year, I'd like to keep as much of that return if I can, after tax as possible.
DO CLIENTS FORGET ABOUT TAXES AND TOTAL RETURNS?
CHAMBERS: Yeah. And that's really kind of important because I think sometimes clients don't remember that in their strategy. Right? They only remember it when they have to pay the tax bill. But they're not thinking about in terms of, okay, well what -- what -- why am I, you know? Right? It's --
MIHAJLOV: I mean, you know --
CHAMBERS: It’s part of your return.
MIHAJLOV: -- short term capital gains are basically somebody's income tax, right. And long-term gains at the high side are 20%. They could be lower depending on your income. But I think it's -- the great thing about investing is you want to keep as much of your return as possible. So that's why I've never been a fan of using mutual funds in taxable accounts.
CHAMBERS: One other thing about mutual funds, can you just talk about their -- their costs? Like, so we're an independent registered advisor. We're a fully independent shop.
A SHARES CLASS VS INSTITUTIONAL CLASS SHARES.
MIHAJLOV: You know, we use institutional share class mutual funds. When we use them, they tend to be of lower expenses than your typical A and C shares or whatever my competition is selling these days with no front end or back-end charges associated with them. So, they tend to be, they, again, they give you the advantages of being a big institution while not necessarily being a big institution.
CHAMBERS: Right.
MIHAJLOV: Tend to like those better. They tend to work better for the average investor. So that's why I use them. But it is frustrating. It's frustrating to see a client give away returns to taxes when they could probably easily avoid doing that.
CHAMBERS: And fees.
MIHAJLOV: Yes.
CHAMBERS: That you don't -- nebulous fees that you don't need.
MIHAJLOV: Right. Correct.
CHAMBERS: Well, my friends, I think what we're saying for is, you know, strive for transparency. You know, if your advisor is not giving you the transparency you need, maybe you should reconsider those services. Well, Mr. Alex, is there anything else you'd like to add is fine pile of awesome google keywords?
MIHAJLOV: Trevor, I would just like it to warm up.
CHAMBERS: Yes.
MIHAJLOV: And, and let's go ahead and bring spring on and shut the cold weather off.
CHAMBERS: Yeah, we are -- we're kind of done, by the way, what's going on in the markets today? What's shaking? How --
MIHAJLOV: Every day is a good day in the market.
CHAMBERS: Every day.
MIHAJLOV: Every day is a good day in --
CHAMBERS: No, actually you can’t say that.
MIHAJLOV: Every day is a good day in the market, Trevor.
CHAMBERS: Alright, well, thank you for your time. We appreciate it. And we will check back. Thanks for joining the Soundtrack to Financial Advisors Life. We appreciate it.
MIHAJLOV: See ya.
CHAMBERS: Bye-bye.
(INTERVIEW CONCLUDED.)
Alex Mihajlov
The arch of his career has now landed his firm, Olde Raleigh Financial, to become a fee-based, Independent Advisory firm. Prior to that Mr. Mihajlov was a branch manager at A.G. Edwards, Wells Fargo and Raymond James. His career has been an evolution and, in turn, his perspective on service has evolved. “My team and I have experienced the large brokerage houses and banks. While they have carved out their spot in the marketplace, I can say it is not for us. We have evolved and we tend to attract those who have evolved away from cookie cutter to a world of customization. They want collaboration. They wanted to be listened too. They want a relationship and we want them to be excited about our relationship.”
Trevor Chambers
Trevor joined Olde Raleigh Financial Services in January of 2015 and his primary role is new business development and marketing. Prior to joining the firm, Trevor spent 12 years working at his family’s restaurant, Raleigh’s Bella Monica Cucina & Vino. “Exceptional service, no matter the industry, is paramount and we attract clients who value and take comfort in being taken care of.”