There’s nothing quite like receiving a year-end 1099, showing a large amount of taxable distributions from a losing mutual fund, to send shareholders scrambling for alternatives that can better manage investment taxes. Buying individual stocks is always one strategy, but investors typically give up the inherent diversification and professional management benefits that mutual funds provide. The increasingly popular exchange-traded funds, which trade like stocks, is another way, but these generally are index funds, not classic actively managed funds. Another method that some investors may want to consider, especially wealthier ones, is separate accounts.
Separate accounts are privately managed investment accounts you can open through brokerage firms or through some independent financial advisors—like MT&C. For example, a financial advisor would help you determine an appropriate asset allocation for your investments, based in part on your risk tolerance and your investment goals, and then use private money managers (sometimes several of them) to select appropriate individual securities to carry out that allocation. Fees are based on the value of the assets being managed.
Investment accounts in Sonoma CountyGoing your separate way offers several advantages; though some critics contend the advantages are not as great as they are touted. Take one of the major arguments for separate accounts—tax management. One advantage with private accounts is that the cost basis is established when you buy. No imbedded taxes inherited from a mutual fund with built-up gains that you didn’t earn but that you pay tax on when those gains are distributed. Also, mutual funds can be forced to sell holdings they don’t want to in order to meet heavy redemption requests from shareholders, thus incurring unwanted capital gains taxes. That won’t occur in a separate account because you are the only shareholder.
However, the argument that separate accounts are inherently “tax efficient” and mutual funds are not raises some debate. First, many equity mutual funds today are considered quite tax efficient because they try to minimize taxes for shareholders through a variety of strategies. And many separate accounts do not focus on tax efficiency; their focus is mostly performance. Also, some separate accounts are more willing than others to work with investors in selling specific securities in order to offset gains elsewhere. Ultimately, if tax efficiency is important to you, then you’ll need to consider that when selecting separate account managers.
The same issue applies to customization of separate accounts. Some managers allow investors to tailor their securities selection; particularly the larger the account. For example, investors sitting on large amounts of company or industry stock might be able to direct the money manager to steer clear of those stocks in order to better diversify their overall portfolio. That’s difficult to do through mutual funds. Or you may not want investments in certain types of stocks such as tobacco or gambling (socially responsible mutual funds do this too).
Separate accounts can have other drawbacks. Minimum account investments typically are $100,000 to $250,000, or even higher, though it’s possible to open accounts with as little as $50,000. That’s still a lot higher than the typical $1,000 to $2,500 minimums for mutual funds. Moreover, the smaller the size of your account, the more difficult it is to buy enough different stocks to obtain adequate diversification. Shifting from a variety of mutual funds into one or two separate accounts will likely dramatically reduce diversification.
Fees are another issue. Fees through brokerage firms generally have come down to around two percent, though that’s still higher than the average mutual fund fee, and it may not always include transaction costs. It’s possible to find separate accounts with fees one percent or less.
Separate accounts don’t work for international investments; you’re usually better off with mutual funds. Also, watch out for “wrap” accounts that use mutual funds, not individual securities. You lose the tax and selection benefits of using individual securities.
Another drawback is that it’s more difficult to obtain accurate private account performance data compared with mutual funds. Private account managers are less regulated than mutual funds. However, a good financial advisor should be able to help you find and monitor dependable money managers.