While you might assume any mutual fund investor should use
Money’s mutual fund record-keeping tools, that isn’t the case.
Because investment record keeping, including mutual fund record
keeping, requires significant work and involves complexity, you
need to make sure the effort is worth it.
In general, you keep investment records for any of the following
reasons:
Reason 1: You want to track interest and dividend income.
Reason 2: You want to track realized and unrealized capital
gains and losses.
Reason 3: You want to measure or grade the profitability of an
investment by calculating its annual return or yield.
Obviously, all three of the tasks in the preceding list sound
worthwhile, but many investors won’t need to use Money’s
record-keeping tools to get this sort of information.
Tracking Investment Income
If your investing is done using tax-deferred accounts, such as
individual retirement accounts, 401(k)s, and other similar
investment containers, you don’t need to track the investment’s
income. The income from tax-deferred investments stored is not
currently taxable. The money you contribute to one of these
tax-deferred accounts can be counted as a deduction when the
money is transferred into the account. Any money you ultimately
withdraw from one of these accounts can be counted as income
when you move money out of the account and into your regular
checking account.
For example, if you contribute money to an individual retirement
account by writing a check on your regular bank account, you can
categorize the check as “IRA contribution” when you write the
check. This categorization lets you easily track the IRA
contribution deduction you will need to report on your tax
return. Similarly, if you withdraw money from an IRA account,
all you need to do is categorize the deposit as IRA income. This
lets you keep track of the IRA withdrawals you will also need to
report on your tax return.
Tracking Capital Gains
As mentioned earlier, realized and unrealized capital gains are
often the second reason for using Money for investment record
keeping. In the case of a regular taxable investment account,
any time you buy and then later sell an investment, you
experience a capital gain or loss that needs to be reported on
your tax return. Because capital gains and losses are important
for your tax return, when you keep records of taxable
investments you want to track these items. You even want to
track potential, or unrealized, capital gains and losses.
However, while tracking unrealized and realized capital gains
and losses is important for taxable investment accounts, you
don’t need to do this for tax-deferred investment accounts like
individual retirement accounts and 401(k) accounts. The reason
is simple. For tax-deferred investment accounts, gains and
losses aren’t taxable. Just as is the case with investment
income, inside a tax-deferred investment account, gains and
losses have no effect on taxable income. Again, the only tax
effect comes from money you move into and out of the account. In
general, money you move into the account is a deduction for
purposes of calculating your taxable income. Money you move out
of your account is an income amount for purposes of calculating
your income tax return.
The general rule described in the preceding paragraph–that
money moved into and out of a tax-deferred investment account is
what produces a tax deduction or taxable income amount–is true.
However, predictably, some tax-deferred investment accounts
don’t work this way. There are, for example, nondeductible IRA
accounts.
A nondeductible IRA account doesn’t give the taxpayer a
deduction merely for moving money into the account. Also, a Roth
IRA account doesn’t actually produce any taxable income just
because you move money out of the account. The primary benefit
of a Roth IRA is that you get to withdraw money from the IRA
without including the withdrawal on your tax return.
However, in spite of the fact that money moved into certain
types of IRAs or out of certain types of IRAs doesn’t trigger a
tax deduction or taxable income, the general rules described
here still apply. Even for nondeductible IRAs or Roth IRAs, you
don’t need to track investment income, dividend income, capital
gains, and capital losses for tax record-keeping using Money.
Measuring Investment Performance
As identified earlier, the third reason for investment record
keeping concerns investment performance measurement. In general,
one of the things you want to do when you become serious about
your investing is calculate how good or how bad an investment
performs. Complete and accurate investment records force you to
honestly evaluate your investing.
One of the ways you measure investment performance is by
calculating the annual return, or yield, produced by the
investment. For example, if you buy a stock for $12 a share and
later sell it for $18 a share, you should calculate the annual
return on the stock. An annual return, or yield, resembles an
interest rate. By comparing the return a stock earns to the
return provided by other investments, you gain a frame of
reference and get a better idea of whether a particular
investment makes sense.
While calculating returns obviously makes sense, note that one
of the tasks your mutual funds management company does is
calculate annual returns. Therefore, you don’t need to duplicate
this effort. In effect, one of the services you are already
paying the mutual funds management company for is the
calculation of this important performance measure.
Mutual fund management companies calculate returns on an annual
basis–typically using the calendar year as the period for which
returns are calculated. Your investment holding period may not
match the period for which the return was calculated. For
example, if you hold an investment for one year but your year
runs from July 1 to June 30, a return measure provided by the
mutual fund company may not be useful if the return is from
January 1 to December 31. Nevertheless, if you use the prudent
mutual fund investment strategy–which is simply to invest for
longer periods, to buy and then hold–the mutual fund management
company’s performance measurements do give you the information
you need.
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