4. Forgetting taxes
James Guarino has seen many investors buy into a fund late in the year, shortly before the fund distributes to holders the net capital gains realized on sales of securities in the portfolio. It may be better to wait until after those payouts, to avoid owing tax before you have made any money on your investment in that fund.
Guarino, a certified public accountant and certified financial planner in Tewksbury, Mass., says investors often make the mistake of not tracking their cost basis in the fund when they elect to have their dividends reinvested to buy more shares. As a result, "huge mistakes" occur as investors end up mistakenly reporting a much larger taxable gain when they sell the fund and thus pay taxes twice -- once on the dividend income and then again when they sell the fund, he says.
Investing in a fund that tends to "churn" its stock portfolio in order to try to maximize returns may also generate large capital gains for investors. This can be a real problem if the fund isn't held in a tax-deferred account such as a 401k or individual retirement account, he says.
5. Taking your eye off the ball
"Investors tend to hold on too long," says Karen Altfest, a certified financial planner in New York. They may react to what has happened in the past and assume a fund will continue to perform well, she says.
A better way to monitor a fund's performance is by setting a target for your holdings amount in line with the prospects of a particular sector fund, for example, and when that target is reached, trim the holdings in the fund or sell it altogether.
"Setting a suitable target can help take the emotion out of the decision to sell," she says.
Altfest says it's "always good" for investors to have their eyes and ears poised to pick up signals that something at a fund or within fund management has changed and then to question "what that is and why that is."
Reading everything from the fund, checking at least once a year that the same management is in place and setting up alerts on the fund are good ways to keep apprised of any changes, she says.
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