The Chicago Tribune reports that taxes paid by mutual fund investors, muted for years by the big losses of the early 2000s, are set to rise again:

LINK

If the formerly red-hot real estate market really tanks, it could drag the entire economy and stock market down with it. The Federal Reserve may even have to lower interest rates if the housing market crumbles in an effort to try to let the air out of the bubble slowly.

In an article for FOX News, MAXfunds co-founder Jonas Ferris focuses in on the core problem in the lending market. Surprise, its not predatory lenders.

Your mutual fund portfolio could take a hit when home prices fall. While most of the damage would be to real estate sector funds that invest in companies that could see their businesses sink if a glut of foreclosed homes hit the market – funds like Fidelity Real Estate Investors (FRESX), Third Avenue Real Estate Value (TAREX), T. Rowe Price Real Estate Fund (TRREX), American Century Real Estate Inv (REACX) - mutual funds that only own REITs (Real Estate Investment Trusts – primarily companies that operate properties for rental income) like Vanguard REIT Index (VGSIX) would also suffer.

LINK

See Also:

The 'Rent vs. Buy' Lie

The 'F' Word: Foreclosure

The Great Real Estate Bubble

The Real Estate Bubble Can Pop

On the fence about whether to invest in mutual funds or individual stocks? You shouldn't be. For the vast majority of investors, mutual funds are the way to go. Barden Winstead in the Rocky Mountain Telegram reviews the inherent advantages mutual funds have over other investments:

Winstead also cites mutual funds' liquidity and low minimum investment requirements.

LINK

Please note: Winstead works for a full service broker, and forgets to mention that many mutual funds are sold without loads of any kind. There is also no discussion of the main downside of mutual funds: expenses. Of course you can always find out if a particular fund has sales loads or is just expensive right here at MAXfunds.com by typing in the fund ticker symbol into our handy dandy Fund-o-Matic search window and then perusing our fund analysis page.

See also: MAXuniversity Part II

Note to subscribers of the MAXadvisor Powerfund Portfolios: this month's portfolio performance data update and commentary has been posted. Subscribers can log in by clicking here.

The MAXadvisor Powerfund Portfolios is a collection of seven model mutual fund portfolios ranging in risk from very safe to quite aggressive. Each portfolio is made up of a group of terrific, no-load, low-cost mutual funds that are carefully chosen to work together to lower volatility and increase returns. You can learn more about the MAXadvisor Powerfund Portfolios (and sign up for a free trial if you like what you see) by clicking here.

One of the dirty little tricks of the fund industry is when fund companies merge the assets of mutual funds with poor performance records into better performing funds. Fund companies know that most investors make investment decisions based on past performance, and that lousy performers are unlikely to be marketable. Merging allows fund companies remove the lousy fund from their roster while keeping investor's money in the family. But Chuck Jaffe reports on recent fund mergers at Fidelity which are unusual because the funds being merged are all top performers:

This could be an acknowledgment that super-targeted funds are under increasing competitive pressure from lower fee (and tradable) ETFs (exchange traded funds).

LINK

Mere days after Vanguard’s new bond ETFs (exchange traded funds) started trading, ETF giant iShares sixteenth bond-focused ETF began trading on the American Stock Exchange.

The iShares iBoxx $ High Yield Corporate Bond Fund (ticker: HYG) is the first junk bond ETF to hit the market, with a record-setting 0.50% expense ratio – more than double iShares most expensive bond ETF and near five times as expensive as Vanguard's new offerings.

There are currently only two players in the bond ETF area: iShares and Vanguard. While bond ETFs by number are a fraction of the increasingly more eclectic ETF area, as Lee Kranefuss, CEO of Barclays Global Investors’ Intermediary and Exchange Traded Funds Business notes "…financial advisors are looking to generate income for their 'Baby Boomer' clients."

Baby boomer retirement - the wave has only just begun and we're already seeing the financial services industrial complex gearing up for the greatest battle for assets in the history of investing. Can't wait. We're already sick of advertisements with classic rock soundtracks or Dennis Hopper waxing poetic about hip retirements afforded by those who choose the right broker.

More info on the new iShares ETF

ETFs are popping up all over, but until now not many have invested in bonds. While some famous rich person once said, "gentlemen prefer bonds", ETF investors clearly do not. While Vanguard was a little late to the exchange traded fund game, in recent years they have put the pedal to the metal in ETF launches. Now Vanguard is launching four new bond ETFs:

• Vanguard Total Bond Market ETF (BND) - Benchmark: Lehman Brothers Aggregate Bond Index
• Vanguard Short-Term Bond ETF (BSV) - Benchmark: Lehman Brothers 1–5 Year Government/Credit Index
• Vanguard Intermediate-Term Bond ETF (BIV) - Benchmark: Lehman Brothers 5–10 Year Government/Credit Index
• Vanguard Long-Term Bond ETF (BLV) - Benchmark: Lehman Brothers Long Government/Credit Index

The benefit of the four new Vanguard ETFs is lower fees – 0.11% compared to the 0.15% - 0.20% cost of the few other bond ETFs. Expenses in bond investing are a big deal as bond yields are low today – the less taken out of your coupon payments, the better. Until trading volumes pick up, investors who don't buy and hold may get a better total price with iShares as thinly traded ETFs tend to cost more to buy and sell.

Vanguard claims, “By operating as share classes of existing funds (rather than as stand-alone funds or unit investment trusts), Vanguard bond ETFs will be able to provide lower expense ratios and broader diversification among issues and issuers than competing products can, resulting in greater credit replication and the potential for tighter benchmark tracking.” In practice, early investors are getting a raw deal.

As of a little after 1PM on April 11th, 2007, the market price for the iShares Lehman Aggregate Fund (AGG) is up 0.19%. The new Vanguard fund based on the same benchmark, Vanguard Total Bond Market ETF (BND), is DOWN 0.15%. AGG has traded 243,000 shares compared to BND’s 14,000.

Why the performance gap? Lack of liquidity means trouble arbitraging the fund with the underlying fund holdings - the mechanism that keeps ETF’s market price close to the NAV. Those who bought BND near the market close yesterday paid a roughly 0.50% premium to NAV, while buyers of AGG paid a 0.20% premium. That’s three years worth of "savings" in fund expenses down the tubes.

Until this problem works itself out, stay away. Or consider Vanguard Total Bond Index (VBMFX). Sure its 0.20% a year, but you buy and sell at NAV commission free (at Vanguard).

Other bond ETFs:

iShares iBoxx $ Investment Grade Co (LQD)
iShares Lehman 7-10Yr Treasury Bond (IEF)
iShares Lehman Aggregate Fund (AGG)
iShares Lehman Credit Bond Fund (CFT)
iShares Lehman Intermediate Credit Bond Fund (CIU)
iShares Lehman 1-3 Year Credit Bond Fund (CSJ)
iShares Lehman Government/Credit Bond Fund (GBF)
iShares Lehman Intermediate Government/Credit Bond Fund (GVI)
iShares Lehman 3-7 Year Treasury Bond Fund (IEI)
iShares Lehman MBS Fixed-Rate Bond Fund (MBB)
iShares Lehman Short Treasury Bond Fund (SHV)
iShares Lehman 10-20 Year Treasury Bond Fund (TLH)

Info at Vanguard.com

A new ruling by the U.S. Court of Appeals in D.C. means that brokers will now be subject to the same regulatory standards as investment advisors. Previously brokers could sell you whatever crappy investment that made them the biggest commission and only pretend to have your best interests at heart, and then not get sued when those investments lost you a bundle:

No, you can't. That's why the founders of MAXfunds.com manage money as commission-free investment advisors, not as brokers.

LINK

Morningstar lists six ways you can make your mutual fund portfolio more tax efficient by minimizing your taxable fund distributions. Tax-efficient funds are those that make very few or relatively small taxable payments to shareholders; some funds try to keep trading activity low (minimizing realized gains which have to be distributed), some watch the way they buy and sell securities in an effort to minimize the tax burden to their shareholders.

1. Invest in Tax-Managed Funds - The managers of tax managed funds take special care to keep taxable distributions to a minimum. They generally don't do much trading, and attempt to "sell losing stocks to offset winners elsewhere in the portfolio." Tax managed funds mentioned in the article: Vanguard Tax-Managed Growth & Income (VTGIX), Vanguard Tax-Managed Balanced (VTMFX), and Eaton Vance Tax-Mgd Value A (EATVX).
2. Look for Closet Tax-Managed Funds - Many funds, such as Oakmark Fund (OAKMX) and Third Avenue Value Fund (TAVFX) don't officially call themselves tax efficient, but have managers that try to keep taxes low.
3. Don't Forget about Index Funds - Index funds track indexes such as the S&P 500, and the people that decide which stocks are included in such indexes don't add or remove stocks from them very often. Because these funds tend to have low turnover, they are generally very tax efficient.
4. Think about ETFs - Most ETFs track indexes, just like index funds do, and hence have low turnover. Low turnover usually equals high tax efficiency. In addition, ETFs unique structure minimizes taxable gains that have to be distributed to shareholders.
5. Make Other Investors' Losses Your Gain - Mutual funds that have had particularly bad performance periods (think tech funds in 2002), can 'carry forward' those losses and offset gains for years to come. This is one we particularly like because it also means you are probably making a contrarian investment – investing where others have just lost money.
6. Houseclean Your Own Portfolio - If you're planning on dumping a fund that has posted a loss, selling before December 31st will allow you to use the loss as a tax deduction on that year's taxes.

LINK

Of course, the most tax-efficient funds are the ones that stink when you own them, because they never distribute profits (there are none!) and often generate nice tax losses when you sell them.

See also:

Ask MAX: Capital Gains Quickies

How Mutual Funds Work - Capital Gains

We live in a world of single-digit yields. No mutual fund is earning a legitimate 10%+ yield today, but that doesn’t stop some fund companies from pretending that they do.

In such a underwhelming investment environment, you can imagine investors’ surprise last week when Forbes.com launched a video entitled “BlackRock's Dividend Machine,” in which BlackRock Enhanced Equity Yield & Premium Fund (ECV), a closed-end fund, reported a double-digit yield. The video is a follow-up to a previous article entitled “Eye-Opening Yield In A Closed-End Fund." Not surprisingly, the fund shot up 1.7% after the video was posted.

The fund is now trading at an approximate 11% premium over net asset value (NAV). In other words, investors are willing to pay $1.11 for $1.00 worth of the fund. And why not? As the article notes, "the fund’s current payout is $2.05 per share, for a yield of 10.06%."

So how is such an eye-opening yield generated? Certainly not from stock dividends. The S&P 500 is currently yielding less than 2%. The fund’s top five holdings, Microsoft (MSFT), ExxonMobil (XOM), General Electric (GE), Qualcomm (QCOM), and Intel (INTC), are the stuff of 2% dreams, not 10%. Besides, the fund’s 1.11% expense ratio would eat up at least half of the dividends collected from the fund's stock holdings.

In fact, the extra yield is actually the result of option writing. Selling, or "writing" call options is a way to earn income by selling off the upside of a stock. The safest way to use options is to sell calls on stock already owned - that way, if it goes up 100%, the option seller can just hand over the appreciated stock.

In contrast, ECV writes naked (uncovered) S&P 500 and S&P 100 Index options that the fund can then settle in cash instead of delivering the underlying stock. The fund owns a similar basket of stocks with a high correlation to these indexes, so their risk is minimal. In most scenarios, this fund would be safer than a regular index fund (about a 10-15% lower risk in a big market drop).

There is a cost for this income and reduced downside, however. The fund will probably never have the upside of a stock fund. In general, option writing strategies allow investors to earn non-bond income. They're particularly effective when stocks go sideways for long periods of time but still demonstrate enough volatility to keep option premiums rich.

Unfortunately, the story is out on option writing. There are now dozens of closed-end funds grinding out yields by selling options. That makes it hard to get a juicy yield going. In fact, in a moderately strong market, investors are likely to see option “premiums” turn into option losses that will have to be settled when those options expire.

In an up market like last year's, investors could expect to earn about 10%, which is quite a bit less than the 15%+ that the S&P 500 delivered. So is that what the fund paid out last year? The 10% return from writing options and collecting dividends? Nope.

Imagine that you bought Microsoft stock at $20 per share and simultaneously sold a call option on the S&P 500 for $2 in proceeds on each unit. If Microsoft rose to $24 and the S&P 500 gained, your $2 index option premium would then turn into a $4 liability, and you'd have to settle up with the option buyer in cash, representing a $2 loss. However, you’d still be up $4 on MSFT, so you would’ve really made $2, or 10% (not the 20% that you would have earned had you bought MSFT outright). If you didn’t sell all of your Microsoft shares to pay the option buyer, you wouldn’t have much of a realized gain.

By law, mutual funds have to pay out all of their realized taxable gains and income - that's why they're not taxed like other companies (shareholders are taxed on distributions instead). But there's no law that says the fund can’t pay out MORE than their taxable gains and income. Doing so is really just handing investors their money back – a non-taxable event. This creates the illusion of a regular, artificially large dividend.

Apparently this magical high-yield fund executed a lot of trades like our Microsoft example, because most of ECV’s 2006 distributions just paid shareholders their money back. Of the bold $2.05 per share paid out last year, a whopping $1.21, or 60%, was a “non-taxable return of capital.”

Is this just nitpicky tax stuff? The fund’s NAV was up 11% in 2006 - they just paid it all out as income, right? Wrong. Lots of funds were up 11% (or more) in 2006. Many paid dividends of a few percent. Unless the funds realized gains of over 10%, they didn’t pay out cash to match their returns. Bottom line - this fund does not yield 10%. It actually lost money on the option writing and just made more on the stock positions.

A similar open-end fund that we’ve recommended in the past (and that we own, both personally and in our model portfolios) is Gateway (GATEX). This lower-risk fund was up 10.15% in 2006. Unlike the more expensive ECV, Gateway didn’t pay distributions in 2006 of 10%. Instead, the dividend was about 1%. Of course, investors could have sold some of their GATEX shares if they'd wanted 10% in “income."

Those who want the income opportunities that come from option writing are better off with GATEX, which, like all open-end funds, trades at NAV, not at a premium to NAV like BlackRock Enhanced Equity Yield & Premium Fund. Someday, ECV will fall back to a 10% discount to NAV when the spotlight is off of option writing. Investors could conceivably lose as much buying ECV at a 10% premium and selling at a 10% discount as they could in any other S&P 500 Index fund.

For the record, in our 2006 HotSheet (free to subscribers of the MAXadvisor Powerfund Portfolios) we recommended NFJ Dividend Interest & Premium Strategy (NFJ), a similar option writing closed-end fund that was better, had lower fees, and had been trading at a deep discount to NAV. NFJ is no longer as much of a bargain, but it's still a much better deal than the BlackRock fund in fees, performance, and premium to NAV.