Record-Breaking Withdrawals in Mutual Funds

Austin, TXThe economic and financial crisis has now resulted in record-breaking mutual fund withdrawals, according to the Investment Company Institute. The Institute reports that investors pulled $127 billion from US stock and bond mutual funds in October alone, while fund assets were reduced to $9.6 trillion as of the end of October.

That $9.6 trillion represents a 22 percent drop from asset peaks, which sat at $12.3 trillion in May 2008. The Institute reports that while investors took $973 million from bond funds in September, they took $41 billion in October. Furthermore, $72 billion was withdrawn from stock mutual funds in October.

The turmoil in mutual funds began in September, when Lehman Brothers Holdings Inc filed for bankruptcy. Recent news that Citigroup requires a huge bailout from the US government will likely not stop investor panic about the future of financial markets.

Meanwhile, some financial experts predict that mutual fund fees will rise in the next year, further penalizing the average investor who is hoping to get out of this economic mess with as few losses as possible. The reason for the forecasted increase in fees is that management fees tend to be tied to the assets in a fund. Funds with more money will often have lower fees, while those with less money have higher fees.
Obviously, with so many people pulling their money from mutual funds, many funds have lost their assets.

What this means is that investors who have already lost 40 percent or more of their investments could be dinged for management fees, as well, although they may be asking why they would pay management fees for funds that are doing so poorly.

And, while mutual fund investors face not only massive losses and potentially higher fees, they may also have to deal with large tax bills because of capital gains taxes, paid on mutual funds that are in taxable accounts. The problem is that the record redemptions in October forced some mutual fund managers to sell positions so they could give their investors the cash they wanted. Those positions were sold even if they performed well—and taxes are charged on income that comes from the sale of a position, even if the fund has suffered losses.

One financial expert, Bob Markman of Markman Capital Management who was quoted in the Star Tribune, says that fund managers should be using losses in other market segments to offset capital gains. "…For a manager to not take those losses and harvest those losses to offset any capital gains is just an indication of laziness and lack of fiduciary responsibility. A manager who wasn't doing this and wasn't offsetting gains with those losses should update their resume and make sure their lawyer's on speed-dial."

So now, investors could face massive losses, higher fees and huge tax bills based on their mutual funds. However, some may be able to recover their losses if their mutual fund managers did not act in their best interests or if the managers marketed the funds as being safer than they actually were.

That may be little comfort to people who are losing a lot of money in the financial crisis right now…but it could mean a lot to them in the future.