Protect Yourself From the Impact of Day Traders

Today, anyone with an Internet connection can obtain real-time information about stock prices that makes trading look easy. And many day traders are buying into this, making rapid, large-volume trades themselves.

You may think these investors are only hurting themselves when things go wrong, but your investments can be affected, too. In fact, day trading can increase stock-market volatility, driving prices to astronomical heights one day and sending them freefalling the next.

Managing purchases and sales can be difficult when the market is moving quickly, and these dramatic shifts can be seriously disruptive for mutual-fund portfolio managers, who typically establish positions for longer terms.

To try to manage volatility, portfolio managers may need to keep more cash on hand for emergency purchases, and may need to sell a security before its ideal time.

Regardless of how talented or seasoned a portfolio manager is, it’s difficult to protect a mutual fund completely from market turbulence caused by day traders. But mutual funds are still great additions to your portfolio: Over the long term, investing in a mutual fund may actually minimize swings in the market.

How? Mutual funds offer diversification that may help lessen the impact of market highs and lows. Additionally, because mutual funds tend to hold securities for long periods of time, they may be better equipped to ride out violent intra-day market swings.

If you – unlike the day traders – are in it for the long term, your mutual funds can be a calming influence in a turbulent market.

A Losing Year Can Still Result in Capital Gains Taxes

Did the taxman come for you in 2013? If so, you may want to consider how to minimize your tax burden in 2014 – and that means understanding that a losing year could still result in capital gains (and capitals-gains taxes).

Capital Gains Aren’t Realized until Assets Are Sold

A capital gain is an increase in the value of an asset (which includes everything from real estate to stocks and mutual funds). The gain is not realized until the asset is sold. So if your investments have appreciated and you haven’t sold them, you won’t have any capital gains, correct?

Not if you own mutual funds, which are pools of investor funds that are managed by a professional. By law, mutual-fund managers must pass through to shareholders the capital gains (and losses) realized from the sale of securities in their portfolios; so you could end up paying capital-gain taxes on your mutual funds even though the fund overall was down for the year.

One Profitable Stock Can Impact Your Taxes

This happens because one security in a mutual-fund portfolio may be sold at a profit, while the majority of securities in the same portfolio are down. As a result, it would be a losing year for the fund, but the capital gain from the one profitable security would be passed on to all the fund’s shareholders.

For example: Your mutual fund bought a security in 2007 for $15 a share. At the start of 2013, the fund sold the security for $30 a share, an overall profit of $15 a share.

However, during 2013, the rest of the fund’s holdings depreciated. So, you’d end up with a down year for the fund, but would still have to pay capital-gains tax for the security that appreciated.

The lesson: Don’t assume that a losing year won’t result in capital-gains taxes – and plan accordingly for 2014.