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June 30 marks the final day for individuals to take action in a way that should help improve their investment careers -- and no, I'm not talking about the final day to sign up for the Rule Maker Online Investment Seminar. Much, much more important, actually, is the Security and Exchange Commission's proposed rule, "Disclosure of Mutual Fund Tax Returns," which remains open for comments from the public through the end of the week.
The rule is really quite simple. It proposes that "mutual funds would be required to disclose after-tax returns based on standardized formulas comparable to the formula currently used to calculate before-tax average annual total returns. The proposals also would require funds that include after-tax returns in advertisements and other sales materials to include standardized after-tax returns."
Now you might think that mutual funds would already provide some way for shareholders to determine what the results of holding a mutual fund in a taxable account would be, but if you did think that you'd be sorely mistaken. At the present time, pretty much only Vanguard (almost always the leader among mutual fund families in shareholder friendliness) provides any way for shareholders to determine what their real returns would have been for owning a mutual fund in a taxable account.
It is expected that the mutual fund industry as a whole will oppose this rule, ostensibly on the grounds that because of living in different states, and having different tax brackets, there is no "one size fits all" method to determine the after-tax results for all fund shareholders. Vanguard cuts through this Gordian knot by using the highest individual federal income tax rates at all times. Those rates are currently 39.6% for dividends and short-term capital gains and 20% for long-term capital gains. State and local income taxes are not considered.
The real reason the mutual fund industry will oppose the rule, however, is that the returns are much less impressive.
The results for any Fools who hold mutual funds in taxable accounts (i.e., outside of IRAs, or 401(k), 403(b), or 457 accounts) can be quite dramatic. Compare the results of the Vanguard 500 Index Fund (commonly referred to around here as "The Index Fund"), with the group of managed mutual funds that invest in large cap companies. (Results are through September 30, 1999.)
Vang. 500 Avg. Large
Index Fd Cap Fd
1 Year Pretax 27.84% 24.67%
1 Year After-tax 27.00% 23.07%
5 Year Pretax 24.95% 20.37%
5 Year After-tax 23.90% 17.90%
10 Year Pretax 16.67% 14.07%
10 Year After-tax 15.46% 11.62%
I've bolded the 10-year returns, as this should give you the best perspective to see by just how much reported mutual fund results are misleading for those who are holding the shares in a taxable account. Figure that, on average, the way that mutual fund results are reported, they overstate by about 2.5% the real after-tax annual returns provided to shareholders if the funds are held in a taxable account. Since managed mutual funds trail the market's average returns by about 2.5% before taking taxes into account, this means that managed mutual funds shareholders have received returns of about 5% less per year than the S&P 500 index provides.
This is important stuff, Fools. Even if you're not a mutual fund investor, you probably know somebody who is, somebody who doesn't even know that he needs your help today. You can make a difference by alerting the SEC that you see nothing wrong with shareholders receiving a bit of a more complete story from the notoriously deceptive mutual fund industry.
Your Turn:
Mail the SEC at rule-comments@sec.gov and put "File No. S7-09-00" in the subject header. Tell them the Fool sent you.
Suggested Links:
The Truth About Mutual Funds: Taxes
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