Year-End Special: ‘Avoid using only active mutual funds in your portfolio’ (2024)

FAQs

Why not buy mutual funds at the end of the year? ›

Near the end of the year, funds typically distribute all or most of their net realized capital gains to investors. If you hold mutual funds in taxable accounts, these gains will be taxable to you regardless of whether you receive them in cash or reinvest them in the fund.

Active funds typically feature higher expense ratios, attributed to the fund manager's in-depth research, analysis, and management efforts. Conversely, passive funds boast lower expense ratios, reflecting the simplified investment strategy and limited involvement of fund managers.

Because mutual funds invest in a variety of different assets, income can be earned from dividends on stocks and interest on bonds held within the fund's portfolio. A fund will typically pay out a portion of the income it receives over the year to fund owners.

Among the benefits they see: Flexibility – because active managers, unlike passive ones, are not required to hold specific stocks or bonds. Hedging – the ability to use short sales, put options, and other strategies to insure against losses.

Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.

Before you buy shares for a nonretirement account in December, call the fund company or check its Web site to find out exactly when the dividend will be paid so you aren't buying a tax distribution. Buy after that date and you'll not only get a lower price, but you'll also avoid a tax bill.

Unless you are very well versed with the markets and have expert knowledge about mutual funds, a good rule of thumb would be to own: Large Cap Mutual Funds: Up to 2. Maybe 3 at best. Beyond that, it doesn't make sense as there will be a great overlap in the shares owned by your mutual funds.

Exiting mutual funds without a prolonged investment horizon is not recommended. Typically, the rule of thumb is to remain invested for four to five years for better equity fund returns and two to three years for debt funds.

There is no fixed timeframe for holding a mutual fund before deciding to sell. However, it's generally recommended to evaluate a fund's performance over three to five years before making a decision. This allows a more comprehensive assessment of the fund's performance across different market conditions.

Yet active managers haven't become better at beating the market over the long term, as Morningstar acknowledges. While the percentage of market-beating funds fluctuates significantly from year to year, the proportion beating over 10- or 20-year periods is still low.

What are the cons of active mutual funds? ›

Disadvantages of Active Management

Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. The investor is paying for the sustained efforts of investment advisers who specialize in active investment, and for the potential for higher returns than the markets as a whole.

Active management takes a hands-on approach. Rather than following preset rules to build a portfolio of stocks or bonds, managers of actively managed mutual funds make buy and sell decisions, selecting individual stocks and bonds according to a rigorous methodology and thorough company research.

However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.

If your stock or balanced fund is paying out a dividend or capital gains distribution, or both, the net asset value (NAV) of the fund will drop by the per share amount of the distributions (most bond funds accrue interest so that dividend distributions do not reduce net asset value).

“If you have additional funds and a long-term investment horizon, topping up your SIPs during market downturns can be beneficial. Buying more units at lower prices can enhance returns when the market recovers. Ensure that topping up your SIPs does not strain your financial situation.

Whether you are buying or selling shares in a mutual fund, most mutual funds execute trades once per day at 4 p.m. ET after the close of the market. Orders are typically posted by 6 p.m. Trade orders can be entered through a broker, a brokerage, an advisor, or directly through the mutual fund.