Not Sure What To Do

[Vincenzo Corleone]

Hi,

I have several managed funds in both taxable and tax-deferred accounts. After learning that only about 4% of all fund managers manage to beat the indexes somewhat consistently, and that index funds have a smaller expense ratio, I've been wondering if it would be worth it to sell my current funds and switch over to Vanguard index funds.

I'd appreciate any comments.

Thanks.

 

[Marshac]

Sounds like the advice given in the coffeehouse investor.... I never have tried the pumpkin pie recipe though

If you're not going to attempt to select and buy individual stocks (smart move for most people), then it only makes sense to go with the lowest expense funds.

 

[brewer12345]

I think it depends. Are there any back-end loads? If so, the decision is a bit more complicated.

Here's a few suggestions:

- In the tax-deferred accounts, it is pretty simple. Managed equity funds should almost certainly be given the boot in favor of cheap index funds or ETFs. I personally think there is room for managed bond funds, but only if the expense ratio is reasonable (.5% or less) and the manager is actually any good.

- In the taxable accounts, you will have to figure out what it would cost you in cap gains taxes from switching and contrast that with how much you would save. I think a simple calculaion of payback period would probably suffice. If you get pay back in 5 years or less, it is probably a no-brainer.

 

[LOL!]

I agree with brewer12345 that should check your "tax liability" for the taxable accounts before you decide to switch.  You might be surprised how low the taxes would be if you tranferred to index funds.  My reasoning is as follows:

1. Taxable accounts usually have distributions each year, so you have been paying taxes on those distributions all along and also increasing your cost basis.  That leaves less embedded tax liability.

2. The stock market represented by the S&P500 has just about recovered back to the levels around year 2000, so if you have funds held for 5 years or so, you may find they have not gained that much overall.   That would be sad, but it may still be true.

3. You may have only recently begun investing.  While funds in general have gone up the last couple of years, you may not have a lot of money in them yet, so tax liability could be less.

4. If you have any funds with losses, you will be able to use those losses to offset any gains and also reduce the tax liability.


And a question for you:  Did/do any of your taxable funds manage to beat the indices somewhat consistently?  Maybe you don't need to switch?  It would be a waste to switch out of Dodge & Cox Stock fund for an index fund.    This is especially true since the former is closed to new investors and if you sold, you would very likely not be able to get back in.