Mutual Fund Liquidations: How to Ease the Pain


Ever wonder what would happen if one of your mutual funds all of a sudden went out of business?

While only a small percentage of funds are “liquidated” or merged into other funds every year, it’s a major headache for investors involved when it does happen. They often have to deal with messy tax calculations, as well as deciding how to reinvest their money.

This year the problem may be worse than ever.

Morningstar (Stock Quote: MORN) reports that 396 funds shut down or merged by the end of August, a pace likely to beat 2008's record 438 liquidations.

When the Fund Stops

Liquidations and mergers occur when funds have performed poorly or are too small to be profitable to the fund company, often because their results are too lackluster to attract investors. That means a shutdown or merger is rarely an investment tragedy. It can actually be beneficial if it prods investors to switch to better funds.

Investors should take several steps when a fund is shut down or merged:

1. Gather Your Records
Once a fund is out of business, the fund company’s information may start to go stale, and it may be difficult to recover data on past prices. That could make it difficult to figure your taxable gains or losses.

Gather all information you can from the fund company while it is still accessible, including your cost basis, or what you paid per share. Also assemble fund-company statements from your files.

If the fund is merged into another fund, make sure the cost basis on the new fund reflects your actual costs of purchasing the old fund, not the price being paid for the new one.

2. Study the New Fund
Don’t simply assume that a new fund selected for a merger is a good substitute for the old one.

Morningstar notes that Old Mutual Funds merged Old Mutual Growth (Stock Quote: OBHGX), which invested in mid-sized growth stocks, with Old Mutual Focused (Stock Quote: OAFCX), a large-company stock and bond fund.

Even if the new fund is perfectly good, it may not fit your investing strategy. And it may not be the best fund in its category. Use Morningstar’s Similar-Fund Finder to locate alternatives.

3. Consider Fees
Before deciding whether to stick with the merged fund or to go with an alternative, be sure the “expense ratio” is not too high. Annual fees of 1% or 2% sound modest but can chew away at returns over the long term.

The Compare Savings Rates Calculator shows that $100 returning 7% a year would increase to $387 in 20 years. If a 1% fee cut the return to 6%, the investment would rise to just $321. With a 1.5% fee, the holding would increase to only $292.

4. Think about Taxes
Like with fees, annual tax bills can stunt returns. Some funds make large annual distributions that trigger big tax bills, while others that perform just as well do not. After calling up a fund on the Morningstar site, click the “Tax” tab to see how taxes have affected results.

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