The new tax break on capital gains that went into effect Jan. 1, under the Taxpayer Relief Act of 1997 will have little, if any, effect on mutual fund holding periods, say industry analysts.
Investors will get a tax break on capital gains realized on assets held at least five years. For taxpayers in the 15 percent income tax bracket, capital gains rates will drop to 8 percent from 10 percent for fund shares held at least five years. For all other investors, capital gains rates will drop to 18 percent from 20 percent. The lower rate would apply only to capital gains realized after January 1, 2006.
"If you have a losing mutual fund or a poor choice in a mutual fund, you would not hold on to it merely to achieve a two percent reduction in your capital gains. By holding on to it you may end up not having any capital gains whatsoever," said Eleanor Blayney, a financial adviser with Sullivan, Bruyette, Speros & Blayney of McLean, Va. "An investor who would be really cognizant of [the tax break] is one who already held a fund for four years and ten months and is trying to determine whether he sells it now or in two months. It's a very at the margin' decision."
Burton Greenwald, president of B.J. Greenwald and Associates of Philadelphia agrees that the upcoming tax break will not have much effect on mutual fund holding periods. "It will certainly encourage people to be longer-term holders of mutual fund shares and in that respect it may be a counterweight to the increasing rate of turnover. It's a positive development but it will not have a substantial impact on the industry," he said.
As a marketing tool, the tax break could be useful to tax-advantaged funds, Greenwald said. "I think that those tax-advantaged funds could very well incorporate this as part of their operating policy, but I don't think you are going to see any (other funds) marketing based upon this. Mostly, it's the tax-advantaged funds that will factor [the tax break] into their equation."
But the tax break will have virtually no impact on how actively managed funds are managed, said Geoffrey Bobroff, president of Bobroff Consulting of East Greenwich, R.I. "If I bought something and I had a good three year run, do I have to hold it for five years because that's what my investors are going to anticipate me doing so that they get favorable tax treatment on their distributions? ... portfolio managers are not inclined to having their hands tied," he said, "While this provision is not necessarily tying one's hands, it may, indirectly, create somewhat of an expectation on the part of investors."