Help for determining whether to dump a fund

Should I dump my fund?

This tool will help you determine whether to sell your current fund and replace it with a different, and presumably less expensive fund. The costs of switching funds include the following:

  • Any commission or back-end load you must pay for selling the current fund
  • Any commission or front-end load you must pay for buying the new fund
  • Capital gains taxes, if your current fund is in a taxable account and has increased in value since you bought it

This tool will tell you how much it would cost in the near term to sell the current fund and buy an alternative. It will also help you estimate future net returns for each of the funds, and determine if and when you might break even after the switch.

The basic method is to project the value of your portfolio under two scenarios, the first where you continue to own your current fund (and pay its estimated rates of costs and taxes), the second where you sell the current fund, pay the switching costs, and reinvest the remainder in the new fund.

A quick lesson on tax-lot accounting

This section applies only to assets held in a taxable account

Each time you buy shares in a stock or fund, those shares comprise a distinct tax-lot (or just plain lot). If you bought, say 100 shares of the asset on a given date and 300 shares on a different date, then you have 2 distinct lots. Note that if your dividend and/or capital gain distributions were reinvested, then every reinvestment creates a new lot. The price you paid for each lot (including any load or commission) is called its basis. All of this matters, because when you sell your shares, the taxman requires you to decide which of your lots you are going to sell, and to determine the basis for those shares.

There are two basic ways (with a few variants) that the IRS allows you to report your basis. One approach is the average cost method, where you average the amount paid for all of your lots. The other approach is to use specific-lot accounting, where you identify at each sale the particular lot(s) that you wish to sell. The latter gives you more flexibility and can save you significant amounts of tax, but may require more record keeping. Once you use the average cost method to sell shares of an asset, you're stuck with that method for all future sales of that asset.

The current version of this tool does not take advantage of specific-lot accounting. Future versions will let you keep track of specific lots. In the meantime, you can use this tool to calculate the switching costs for a single lot of shares, or for a block of shares that you choose to treat using the average cost method.

How much is invested in the current fund?

The current value of your shares in the fund that you're thinking of selling.

What is your cost basis?

(Applies only to shares in a taxable account)

The amount you paid for the shares that you're thinking of selling. If you simply want to estimate the future performance of the two funds, enter the same number as the investment amount.

When did you buy the fund?

(Applies only to shares in a taxable account)

Select More if you purchased the shares more than a year ago and qualify for long-term capital gains treatment. Select Less if you purchased the shares within the last year.

What is the cost of selling the current fund?

The broker commission or back-end load for selling the fund that you currently own, whichever applies. Check your fund prospectus and/or your broker's commission schedule to determine the applicable fees. In some cases the cost may be given as a percentage of the value of the shares, in other cases it may be given as a specific dollar amount. If either the dollar amount or percentage does not apply in your case, you may set that box to 0 or leave it blank.

What is the cost of buying the new fund?

The broker commission or front-end load for buying the fund that you're thinking of buying, whichever applies. Check your fund prospectus and/or your broker's commission schedule to determine the applicable fees. In some cases the cost may be given as a percentage of the value of the shares, in other cases it may be given as a specific dollar amount. If either the dollar amount or percentage does not apply in your case, you may set that box to 0 or leave it blank.

What do you expect the expense ratio to be in the future?

In most cases you should leave the default.  However, you may want to change the default if your fund is currently waiving its normal fee, or if it is a "fund of funds" that invests mainly in other funds. In the latter case, the default expense ratio might not include the expense ratios for the funds that your fund owns.  Be sure to read the fund's prospectus carefully to see what it says about fees and expenses.  Also, many funds do raise (or lower) their fees.  You may want to experiement to see the effects of possible changes.

What do you expect for turnover?

The default value is last year's actual turnover.   High turnover funds seldom become low turnover funds, or vice versa, but with actively-managed funds, turnover can vary somewhat from one year to the next. (The variation with low-turnover funds, such as most index funds, is likely to be a lot lower.) You should adjust this number if you believe that future turnover will be significantly different from last year's.

 

What are the fund's transaction costs?

We multiply this number by turnover to estimate the fund's actual transaction costs. Our default value depends on the type of fund, for example, 1.24% in transaction costs for every 100% turnover -- $1.24 for each $100 of assets in the fund for a larger-cap U.S. stock fund. For a Municipal Bond fund, the default value is 0.43% in transaction costs for every 100% turnover.  This estimate is based on statistical studies only. It would be nice if the funds told people what their transaction costs actually were, but this would be difficult.  (The brokerage commissions would be easy to quantify, but not the "market-moving" costs of their moving in and out of a stock.)  And in any event, they don't.  So the best we can do is estimate.  You may want to adjust this number if you have information suggesting that the fund's internal transaction costs are different from the category defaults.

What do you expect for average dividend yield?

(Applies only to shares in a taxable account)

This is your estimate of the the future dividend yield on the fund. Namely, the dividends it passes through to you from stocks and the interest it passes through to you from bonds.  (It does not include capital gains distributions.)

Our default value is last year's yield.  If the fund began the year at $10 a share and paid out 30 cents a share in dividends -- that would be a 3% yield. 

Yields fluctuate.  The current yield on the S&P 500, for example, is about 1.4%, while the historical average has been about 4%.  You may wish to adjust the expected yield if you believe future yields will be significantly different.  The two things that would send low yields higher in a stock-market mutual fund would be:  A corporate trend toward paying out a higher percentage of profits in dividends.  (Right now, for tax reasons and to enhance management stock options, the reverse trend has been dominant.)   Or, second: A sharp drop in stock prices relative to profits.  But if you are assuming a fairly high rate of growth for this fund, you are probably not assuming a sharp drop in price/earnings ratios.

 

What percentage of the fund's capital do you expect to be distributed as taxable capital gains each year?

(Applies only to shares in a taxable account)

I'm sorry, but this is almost a trick question, so you have to pay attention.  What you would expect here is a number like 25% -- the fund began the year at $10 a share, and appreciated by $4 a share, say, over the course of the year, including good gains in a lot of stocks it still owns.  It sold some of its winners along the way and (net of losses from any losers it sold) wound up sending you $1-a-share in taxable capital gains distributions.   That would be 25%.  Namely, it appreciated by $4 and sent you a taxable distribution 25% as big.

But that's not the number we're looking for.  Rather, we want to know how that $1 in taxable gains compares not with the year's $4 of appreciation, but with the entire $14 value to which your shares had appreciated.  So in this example, the answer would be 25% -- one-fourth of $4 -- but about 7% -- one-fourteenth iof $14.

Sorry to do this to you.

The default value is based on last year's actual results.  If you believe that the fund's future rate of realized capital gains will be different from last year's, adjust this value.

An adjustment cries out to be made particularly in two kinds of cases:

* Say the fund lost money last year, or made just a little.  And it paid out NO realized gains, because, truthfully, it had none.  Or very few, which were more than netted out by its realized losses.  We would show it with a 0% default value, meaning we expected it never to expose you to any taxable distributions.  Well, this is ridiculous.   Yes, there are some funds that are so well tax-managed that you can fairly assume little if any taxable capital gains distributions will be made each year.  But in this example, it wasn't brilliant tax management that produced the good result (buying and holding, ornfinding losses to offset gains when selling) -- it was rotten investment returns.   So unless you are projecting continued rotten returns (in which case, you probably don''t need to go much further with your analysis to know what to do with this fund), you should most surely adjust our default number.  For example, if you're projecting a 12% annual return from this fund before costs . . . and if you figure most of that will come from appreciation as opposed to dividends . . . and if you figure that 30% of that appreciation will be mailed to you in the form of taxable capital gains distributions each year . . . then an appropriate guess for this field would be about 3%.   (You are expecting 12% in total return from the fund before fees and such.   But after fees, and after allowing for the fact that a little of that return will come from dividends, maybe you're looking to 10% in appreciation, of which you figure 30% may be distributed in realized, taxable gains: namely, 3% of the total investment.)

* Or say the fund had a spectacular year last year.  Up 100%!  It started the year at $10 and ended at $20 just before it paid out $5 in taxable gains.  The number we would show here is thus: 25%.   (Because $5 is 25% of your entire $20-per-share investment.)  But now, say, you have told us you expect the fund to grow at a more sensible 10% a year.  After all, looking forward 10 or 20 or 30 years, that's a lot more reasonable to expect.  No way would taxable distributions in this situation equal 25% of the value of your shares each year.  If you stuck with our default, you'd get a crazy, stupid result.   (Admittedly, this is a pretty crazy, extreme example.)  Chances are, you'd want to use a figure more like 5% in this example.  (If the fund continues to pay out about 50% of its appreciation each year, and it appreciates 10% a year, then it's paying out about 5% in taxable capital gains distributions.)

What percentage of the distributed capital gains do you expect to be short-term?

(Applies only to shares in a taxable account)

Our default value, 30%, is based on industry averages.  Unfortunately, public filings such as annual reports and prospectuses seldom contain this information.  So if you want a more accurate figure your best bet may be to look at your own account statements (if you've owned the fund for any length of time) or call the fund family.

How much would it cost to sell the fund in the future?

This is similar to the earlier question about selling the current fund, and in fact we use the values you specify for the present-day trading costs for the future trading costs. However, you may wish to set the future costs to be different from the present costs if, for example, your fund has a back-end load which declines over time.

How long until you expect to liquidate the investment?

The number of years until which you would sell the shares – either your current fund, if you choose to hold it, or the new fund


Help for the results page of the "Dump This Fund?" calculator

Taxes Paid

This is the capital gains tax you would pay in the current tax year to sell the current fund. If you indicated that these shares are in a tax-sheltered account, this value would be 0.

The formula we use is to take the proceeds of the sale of the current fund, defined as:

P = A *(1 - sp) - sd, where:

A = the amount invested in the current fund
sp = the percentage cost of selling the current fund
sd = the dollar cost of selling the current fund

the gain on the sale is:

G = P - B, where B is the cost basis

if G < 0, then the tax = 0
otherwise, the tax paid = G * tax_rate, where tax_rate = your long-term capital gains rate if you indicated that you bought the fund more than one year ago, or your income tax rate if you bought the fund less than one year ago.

Commissions and/or loads

The total cost of selling the current fund, and buying the new one.

The simplest way to present the formula is:

A = the amount invested in the current fund
N = the amount invested in the new fund, after paying all commissions and loads, as follows:

N = (A*(1 - sp) - sd - bd)*(1 - bp) , where:

sp = the percentage cost of selling the current fund
sd = the dollar cost of selling the current fund
bd = the dollar cost of buying the new fund
bp = the percentage cost of buying the new fund

Thus the (pre-tax) switching cost = A - N

Total switching cost

The sum of the taxes paid and commission and/or loads, as defined above

Gross Return

This is your estimate of the future gross return for the fund, before deducting any costs or taxes.

 

Cost

This is the funds' estimated future investment cost. It is the sum of the expense ratio and transaction cost (as a function of turnover). We show it on this page mainly as a sanity check for the projections. If you do not agree with this value you can go back to the previous screen, fine-tune your assumptions and recalculate.

Yield

(Applicable only to a taxable account. Even though a fund in a tax-sheltered account may have a yield, we don't compute it as it won't affect this analysis)

This is the fund's estimated future dividend yield. We show it on this page mainly as a sanity check for the projections. If you do not agree with this value you can go back to the previous screen and fine-tune your assumptions.

Gains Return

(Applicable only to a taxable account. Even though a fund in a tax-sheltered account may distribute gains, we don't compute it as it won't affect this analysis)

This is the fund's estimated future rate of capital gains distributions. (It is the value "g" in the formulas at Net Return, below) We show it on this page mainly as a sanity check for the projections. If you do not agree with this value you can go back to the previous screen, fine-tune your assumptions and recalculate.

Appreciation Return

(Applicable only to a taxable account. We don't compute this value for a tax-sheltered account as it won't affect the analysis)

This is the fund's estimated future (undistributed) capital appreciation. (It is the value "c" in the formulas at Net Return, below) We show it on this page mainly as a sanity check for the projections. If you do not agree with this value you can go back to the previous screen, fine-tune your assumptions and recalculate.

Reinvestment Return

(Applicable only to a taxable account Even though you may reinvest distributions in a tax-sheltered account, we don't compute this value as it won't affect this analysis)

This is the fund's estimated future rate of reinvested distributions. i.e. the amount that would be reinvested in the fund after paying taxes on dividends and capital gains distributions. For example, suppose that the fund has a starting value of $10 per share, and a value one year later of $11 per share. At the same time, the fund also distributes $0.30 per share in dividends and $0.50 per share in long-term capital gains. Assume also that your income tax rate were 28% and capital gain tax rate were 20%. Thus the fund would have the following values:

Appreciation Return: 10%
Yield: 3%
Gains Return: 5%
Reinvestment Return: 6.16% = 3% * (1 - 28%) + 5% * (1 - 20%)
Net Return: 16.16%

We show the Reinvestment Return on this page mainly as a sanity check for the projections. If you do not agree with this value you can go back to the previous screen, fine-tune your assumptions and recalculate.

Net return

This is the estimated net return for the fund, after adjusting the gross return for investment costs (and taxes if held in a taxable account). The formulas we use are as follows:

Tax-Sheltered Case:

r = R - e - T * t

R = gross return
e = expense ratio
T = turnover
t = transaction cost (per 100% of turnover)

Taxable Case:

r = c + y*(1-i)  + S*g*(1-s) + (1-S)*g*(1-l)

c = capital appreciation -- see below for definition
y = yield
i = applicable rate of income tax (will be 0 in case of muni bonds)
S = percentage of distributed gains that are short-term
g = distributed gains -- see below for definition
s = tax-rate on short-term gains
l = tax-rate on long-term gains

distributed gains, g, and capital appreciation, c, are defined as:

g = (1+C) * d

c = (1+C) * (1-d) - 1

where:

d = percentage of capital to be realized as gains
C = raw capital appreciation, defined by

C = r - I - y

where:

r = gross rate of return on assets before costs.
y = yield
I = investment cost (sum of expense ratio and transaction costs)

In other words, we estimate the expected capital appreciation for the fund by subtracting yield and investment costs from total return (the result is C).

Then we use a ratio (d) to figure out how much of this capital appreciation will be distributed (g) and how much will stay in the fund (c).

From there we figure out the long-term and short-term components of (g).  We assume that taxes are withheld from any distributions and the remaining portion  of the distribution is reinvested.

Year

Each row of this table shows how much each investment would be worth at the end of each successive year. The "1" row indicates how much the fund would be worth 1 year after switching, etc.

Pre-tax value

The market value, at the end of each successive year, of each investment, before paying any sales charges or capital gains tax. This is how much the fund would be worth if you donated it to charity, of if it were left to your heirs.

The formula used is (1+r)N, where N is the number of years that you hold the investment and r is the Return Net of Costs and Taxes, as described above

This is the most optimistic estimate of future value, as it doesn't take into account any taxes to be paid at the time of the sale.

If you're evaluating funds in a taxable account, you'll want to compare both the Pre-tax value and the After-tax value for each fund. For a tax-sheltered account, you'll still pay tax when you withdraw assets from the account, but the Pre-tax value is a level playing field for comparing two funds.

After-tax value

(Applies only to shares in a taxable account)

This shows the vaue, at the end of each successive year, of each investment after paying sales charges and capital gains taxes, assuming that the entire investment is sold.

To compute this value, we compute the cost basis to be the sum of your stated cost basis, plus the value of any dividend or capital gains distributions along the way.

This is the most pessimistic estimate of future value, as it assumes that the entire investment is sold all at once. If you sell only a portion and hold the remainder (or donate it to charity, or leave it to your estate), the actual value will be somewhere in between the Pre-Tax value and the After-Tax value.

Pre-tax difference

After-tax difference

This shows the difference between the scenario of holding the current fund for the given number of years vs. the scenario of dumping the current fund and replacing it with the new fund. (one column takes the difference of the pre-tax values, the other, applicable only to taxable accounts takes the difference of the after-tax values)

If the value is positive (in black), it means that you would have made more money by switching, if the value is negative (in red and in parentheses like this: $(923.04)), it means that you would have been better off holding on to the current fund.

Assuming that the net return on the new investment is higher than the net return on your current fund, there will be some year in which the difference is positive. The first year with a positive difference is the break-even point for the switch. The break-even point may be different for each of the pre-tax and after-tax differences.

Required improvement

For each year, this column indicates the amount by which the net return of the new fund must be greater than the net return of your current fund in order for you to break even (before tax) within that number of years.

For example, if the expected net return for your current fund were 9.7%, and the Required improvement for year 3 were 1.8%, then the new fund would have to have a net return of at least 11.5% in order to break even in 3 years.

Based on the estimates of future costs, we determine the estimated difference in returns between the two funds. Naturally, because these are only estimates, the actual outcomes can vary dramatically from these estimates. The "Required Improvement" number can help you gauge the margin of error. In other words, if the estimated net return of the new fund is greater than the estimated retun of your current fund by a lot more than the "Required Improvement", then your confidence in breaking even should increase. On the other hand, if the "Required Improvement" is much more than the estimated difference, your confidence in breaking even should decrease.

In the table we show a Required Improvement that is greater than the estimated difference in returns in red, and a Required Improvement that is less than the estimated difference in black.

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