It makes complete sense. After all, you're trusting this person(s) with your money. And that's the key word...trust. If they make some bad decisions then you, the investor, are the one who pays for it.
Of course, when you invest in a mutual fund, there is always a chance that you can lose money. That isn't always the portfolio manager's fault. Even the best portfolio managers sometimes cannot keep their mutual fund in positive territory. You need to trust the portfolio manager in their stock picking decisions but you also need to trust them with how they handle the stocks.
Before we get into how important it is to trust the portfolio manager's ability to handle the stocks, you might need a brief explanation of capital gains. When a stock goes up in price and you sell it, the difference in the price you paid for it and the price you sold it for is the amount of capital gains you received. It's always nice to make money in a stock or mutual fund but the IRS (Internal Revenue Service) taxes you on your capital gains based on your current income tax bracket.
Did you know that you can receive a huge tax bill from the IRS for capital gains even if you never sold a single share of the fund? It's true, and in fact, the fund's NAV (Net Asset Value) doesn't even have to go up that year! So, technically, the fund can be losing money but you are still charged for taxes. This happens when a portfolio manager sells the stocks in the portfolio that have gone up but they haven't sold the stocks that have declined.
A good portfolio manager can and will usually prevent this from happening. He can reduce the amount of capital gains that are paid out by offsetting the gains with the losses. He does this by selling both stocks that have gone up and stocks that have gone down that year. By doing this, the portfolio manager helps to lessen the burden that shareholders feel when it comes to tax season.
If you are unsure about a certain portfolio manager's ability to handle capital gains, you can check in their prospectus and it will usually tell you how much money in capital gains is paid out each year to shareholders. You can use this to judge if you want to pay that much in taxes. Also, prospectuses often have information about the portfolio manager himself.
If you feel that you are being taken advantage of when it comes to the portfolio's ability to handle the capital gains, you can contact the mutual fund family and speak to a fund representative. If you still feel uneasy and you cannot trust your portfolio manager it would probably be wise to take your money out and put it into a mutual fund that you have more confidence in. After all, you don't want to give your money to someone that you don't have confidence and trust in.
This article wasn't meant to scare you away from investing in mutual funds. Most portfolio managers are good at managing the stocks but every once in a while a fund manager makes a couple bad decisions that hurt the investors. So if you are planning to invest in a mutual fund or are already invested in one, it is important to understand how your fund manager manages your money.
