The Motley Fool Previous Page

Now May Be a Terrible Time to Invest

Claire Stephanic
December 17, 2007

More than 90 million fund investors in America agree that mutual funds can be a superior investment vehicle.

Heck, a simple market-tracking index fund guarantees you the market's return -- historically 10% per year. That means that an initial investment of $25,000 will turn into $1.1 million over the course of 40 years -- without having to put in hours of research.

Convenience is king
Funds are convenient. They leave the stock picking to paid professionals, while providing instant diversification. Take the T. Rowe Price New America Growth (PRWAX) fund, for example. Buying shares of this fund gives you exposure to stocks large and small, across all sectors -- Southwest Airlines (NYSE: LUV  ) , eBay (Nasdaq: EBAY  ) , and Adobe Systems (Nasdaq: ADBE  ) as well as (NYSE: CRM  ) , General Electric (NYSE: GE  ) , Microsoft (Nasdaq: MSFT  ) , and Broadcom (Nasdaq: BRCM  ) . All these stocks appear in the fund's top 25 holdings.

Manager Joseph Milano has been with T. Rowe Price since 1995 and has guided this fund specifically since 2002. His track record over the time is solid, with the fund returning more than 13% annually. That's a full percentage point ahead of the market, and this year has been particularly good -- year to date the fund is more than 8 percentage points better than the S&P 500 index. With a talented management team, low fees, and solid performance, T. Rowe Price New America Growth looks like a winning investment.

However, now may be a bad time to invest.

Hi, I'm Uncle Sam
See, most mutual funds distribute income and net capital gains to shareholders in November or December. The profit from the sale of these securities is taxed, whether or not individual investors sell their fund shares.

If your fund shares are in a taxable account (i.e., outside a 401(k) or IRAs), you'll owe Uncle Sam if the fund manager sells investments at a profit.

This poses a problem for fund investors who make initial purchases near the end of the calendar year. They'll immediately receive taxable income without having been in the fund long enough to enjoy the gains that brought those taxes!

It's estimated that 2007 will see a significant rise in capital gains taxes, in part because of market volatility. With the housing and subprime meltdowns, fund managers traded more frequently, perhaps as a flock to quality.

Now, I said it may be a terrible time to add new money. There are two important caveats to note. For one, as master fund manager Ron Muhlenkamp has said, the tax tail shouldn't wag the investment dog. While taxes should certainly be a factor, they shouldn't be the sole basis of a buy/sell decision. It just so happens that November and Decem