(PUB) Investing 2015

17

December 2015

Morningstar FundInvestor

3 Rebalancing Without Considering the Tax Consequences

Capital Gains Update It’s capital gains season. Here’s what we’ve heard so far: American Funds American Funds Growth Fund of America AGTHX is anticipating one of the larger distributions, amount- ing to between 8% and 10% of assets. American Funds Investment Company of America AIVSX is estimating a distribution of between 7% and 9% of net asset value, while American Funds New Economy ANEFX and American Funds Smallcap World SMCWX are both anticipating distributions in the range of 6% to 9% of NAV . Fidelity Among the Fidelity funds that are anticipating capital gains distributions, many amount to less than 5% of NAV . However, a handful of larger funds will be making more meaningful distributions, including Fidelity Capital Appreciation FDCAX with 11% of NAV and Fidelity New Millennium FMILX with 10% of NAV as of Sept. 30 . T. Rowe Price T. Rowe Price Growth & Income PRGIX , which had a manager change earlier this year, is anticipating a distribution of about 14% of its NAV . T. Rowe Price Small-Cap Value PRSVX is anticipating a distribution of $7 per share, or 15% of its recent NAV . Vanguard Among the Vanguard funds anticipating a sizable capital gains distribution later this year is Vanguard Explorer VEXPX ; the firm expects a roughly 9% distribution as a percentage of NAV from the fund, which also made a sizable distribution in 2014 . Vanguard Strategic Equity VSEQX anticipates a distribution in that same ballpark of 9% of NAV . Vanguard Capital Value VCVLX and Vanguard U.S. Growth VWUSX expect to make capital gains distri- butions that amount to roughly 8% of their NAV s, while Vanguard Diversified Equity VDEQX , Vanguard Mid-Cap Growth VMGRX , and Vanguard Morgan Growth VMRGX are each forecasting distributions in the 7% range. K Contact Christine Benz at christine.benz@morningstar.com

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Year-end portfolio reviews often entail rebalancing— trimming highly appreciated securities while boosting positions in securities that have fallen in value. Adhering to a consistent rebalancing regimen can reduce a portfolio’s risk level while also building in a contrarian streak. But even though rebalancing is sensible from the standpoint of portfolio optimi- zation, it has the potential to jack up transaction and tax costs. That’s one reason why it’s usually advi- sable to concentrate any rebalancing activity in tax- sheltered accounts like IRA s and 401 (k)s, where trading costs are low and selling doesn’t trigger a tax hit. On the flip side, it’s worth employing a lighter touch in taxable accounts. certain asset classes, categories, or sectors, be careful about what you add to correct those imbalances during the fourth quarter. That’s because mutual fund capital-gains-distribution season is upon us, and if you add a holding to your taxable account before it makes a payout, you’ll be subject to taxes on gains you weren’t around to enjoy. If you want to make adjustments straightaway, a better bet is to focus on broad-market index funds and ETF s, which tend to do a good job of limiting taxable distributions. 5 Reflexively Dodging Capital Gains Distributions If you expect a fund that you’ve owned for a while to make a sizable distribution and you hold it in a taxable account, selling pre-emptively can make sense if you wanted to lighten up on the position anyway— if it’s taking up too large a share in your portfolio, for example. But if you like the holding and weren’t planning to sell, it’s rarely a good idea to preemptively sell a long-held position. After all, you’re apt to have your own capital gains in the fund, so even if you were to sell in time to avoid the distribution, your selling would trigger capital gains taxes based on the difference between your purchase price and the current share price. 4 Buying Ahead of a Distribution If a portfolio review indicates that you’re light on