This week's panel:

Do distributions affect the cost basis of the fund?

What's your take on APGB?

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Do distributions affect the cost basis of the fund?

from Bill

Q: Do mutual fund capital gain distributions affect the basis cost/price of the fund? Are they treated the same as a stock, which is paid a taxable dividend?

A: (Lou) Any mutual fund distribution affects the share price of a mutual fund. For example, let us suppose a mutual fund before a distribution is priced at $10.00 per share. Then a long-term capital gain of $.50 is distributed and a dividend of $.25 is distributed. The market value of a share of the mutual fund immediately after the distribution would be priced at $9.25.

Dividends are treated the same as dividends distributed from a stock for tax purposes. Long-term capital gains distributions from a mutual fund are taxed at a maximum of 20% tax rate although lower tax rates could apply depending on one's circumstances.

The cost basis of a mutual fund for a specific share lot (a specific amount of shares both at a specific price and on a specific date) is unaffected unless there is a share split. However, those investors that use average cost basis (We never recommend using average cost basis which is what the mutual fund groups supply, because it will cause you to pay higher taxes than necessary if you are selling only a portion of the fund) and/or reinvest their distributions.

We don't recommend that investors reinvest their distributions in taxable accounts unless they are buying strictly loaded mutual funds. By not reinvesting distributions, which is essentially new cash, it is less costly to rebalance their portfolios and/or they now have cash to live off of if they withdraw money from their mutual fund accounts.

We recommend that all mutual fund shares be housed at a discount brokerage firm and not held at the individual mutual funds. Otherwise, it becomes difficult to rebalance funds in a tax-efficient manner.

At a discount brokerage firm, as distributions are made, the cash flows into a money market fund ready to be placed directly into a new fund rebalanced among the existing funds and/or distributed to the investor.

What's your take on APGB?

from Elizabeth

Q:  My financial advisors are urging me to sell my shares in APGB (Alliance Premier Growth Fund) as Morningstar has downgraded it to 2 stars.  What's your take on this fund?  Have held it since '99 and selling it would result in  loss of principal and of course the fees associated with premature withdrawals.  I'm retired, age 70 1/2 and this fund is part of my IRA/401(k) rollover.

A: (Cathy) While I agree with your advisors that you should rid yourself of the APGB fund, their reason for doing so leaves a bit to be desired. I have very little confidence in the categories and ratings assigned by Morningstar. They have a good reputation, but, their system is not flawless.

The question of buying or selling a fund should not hinge solely ratings or recent performance. You must consider several key factors including, but not limited to:

-cost (expense ratio, sales charges)

-taxes (none in your specific case)

-investment strategy (How does the fund fit into your overall asset allocation?)

-style drift

Your Alliance Premier Growth fund boasts a whopping 2.13% annual expense ratio!! Ouch, that's 2.13% less return year after year! As if that weren't enough to make you blow a gasket, you get to pay a 4.0% back end load when you sell it. You should have a few words with the guy/gal that sold this to you. They made a killing I'm sure!

This may be a biased response, but in my opinion it's the right response. The asset allocation decision accounts for over 90% of the results investors achieve. Attempts to either select individual securities or time market movements have contributed very little to variations in returns, and in most cases that return has been negative. So why pay a fund manager to try and outguess the market? (especially at 2.13% per year) Just buy the index. Bottom line is, index funds are the lowest cost, lowest risk, and lowest tax cost solution to reliably capture the performance of the world's markets. Retail fund families like Vanguard and institutional fund families like DFA deliver some of the best index funds around with very low expense ratios. Please note that DFA funds are only available through investment advisors.

The best thing you could do for yourself is to sit down and evaluate an allocation plan that will best suit your needs and objectives. If the current funds don't fit the model, dump them. Sometimes you just have to bite the bullet and not look back.

Important Disclaimer

Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful. Returns vary and you may have a gain or loss when you sell your shares. Past performance is no guarantee of future results. Index returns shown are historical and include the change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged and do not reflect the impact of transaction costs. Transaction costs would have reduced the total returns.

International investments, especially those in emerging markets, entail greater risks (as well as greater potential rewards) than U.S. investing. These risks include political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less-established markets and economies.

Lastly, the questions and responses set forth here are for general informational purposes only and are not intended to substitute for performing your own independent research or contacting your financial or legal professional before making any investment decisions. We make no guarantees as to the performance of any investment strategy you choose and are not responsible for any losses you might incur.