There are many different reasons why investors decide to purchase mutual funds and hold them long-term. However, one of the main reasons for doing this is to avoid paying transaction charges, capital gains and management fees.
Many mutual funds carry “load fees.” These are transaction charges that you will pay if you decide to purchase some types of mutual funds. In addition, you may even pay a load fee if you decide to sell a mutual fund. Financial institutions place load fees on mutual funds to discourage individuals from frequently buying or selling these assets in hopes of timing the markets. For example, if you had to pay a load fee that is equal to 5 percent of your deposit, and you decide to invest $10,000, you would pay a load fee of $500. That fee would quickly add up if you frequently bought and sold that specific mutual fund.
Another reason why you may want to hold a mutual fund long-term is to avoid paying capital gains. Anytime you sell a mutual fund after it has increased in value, you are subject to paying taxes on the capital gains you receive. While you may think that you can time the market, it may be best to hold longer-term and ride out the dips and spikes that the market provides.
Most mutual funds will have a management fee that is equivalent to 1 to 2 percent of the total amount of funds that are currently under management. While this may seem like a small amount, it can add up during years when a specific mutual fund is not showing any profits. Typically, a specialized mutual fund will go through market cycles that have it booming one year and doing little in another year. If you were to try and time the markets for each specific sector, you may end up wiping out any profit that you have accumulated. It is usually better to hold a mutual fund for the long-term as it may increase a large percent during short bursts of action, which are difficult to catch if you are not invested all the time.
Periodic Consolidation And Distributions
All three of these factors come into play when you hold a mutual fund. However, there may be times when you see a drop in value during late December or early January. When this occurs, it is usually due to distributions that are being made. These come in the form of dividends, and they reduce the value of the actual fund that you are holding.
Throughout the year, fund managers may buy and sell multiple times. This would be a logistical nightmare to pay taxes on so they are allowed to make distributions near the end of the year. When these funds are distributed to mutual fund holders, they are also taxed. This will reduce the net asset value (NAV) of the fund.
Jim Treebold is a North Carolina based writer. He lives by the mantra of “Learn 1 new thing each day”! Jim loves to write, read, pedal around on his electric bike and dream of big things. Drop him a line if you like his writing, he loves hearing from his readers!