section 1 - The American College Online Learning Center

(1) Berstresser, Chalmers, and Tufano (2009) 12 show that broker-sold fundsunderperform direct sold funds, even before subtracting 12b-1 marketingfees. The broker-sold funds also do not have lower nondistributionexpenses to make up for their higher distribution expenses. However,there is greater money flow into funds with higher distribution expenses,which suggests that funds are “sold, not bought.”(2) Similarly, Morey (2003) 13 finds that load funds significantly underperformno-load funds on a load-adjusted basis.(3) To minimize this, the planner must require communication with the clientabout how the advisor is being paid. This ties back into the beginning of thelearning objective about what value advisors bring to the client relationship.LO 3-6-2: Choosing appropriate asset location to improve after-taxinvestment performance1. What is asset location? (Video: In a tax-deferred account what percent of principal iseffectively owned by the individual investor? Littell, Nanigian, Reichenstein)a. Asset location is not asset allocation. Asset allocation is the percentage of fundsinvested in stocks, bonds, and cash.b. Asset location is the type of account in which the asset is locatedc. For example, a stock mutual fund can be held in a taxable brokerage account, atax-deferred 401(k) plan, or a tax-exempt Roth IRA.2. What is the portion of the principal owned in a tax-deferred account owned by an investor?a. The answer is based on the investor’s tax rate.b. To determine the investor’s portion take one minus the tax rate to determine theinvestor’s portion.c. The government’s share in the account is the tax rate.d. Example: Individual has a 25 percent tax rate, the investor owns 75 percent of theaccount principal and the government owns 25 percent.3. What percentage of the returns in a tax-deferred account are received by an investor?a. In a tax-deferred account the after-tax return does not grow tax-deferred, it growstax-free.b. Example: The investor has a $10,000 tax-deferred account and is in the 25percent tax bracket. The account earns 100 percent return. The account growsto $20,000 and after-tax the investor receives $15,000. Since the pretax returnis 100 percent (account grows from $10,000 to $20,000) and the after-tax returngrows 100 percent (after-tax account grows from $7,500 to $15,000) the effectivetax rate on the return is zero.c. The pre-tax return is equal to the after-tax return. The collective tax rate is zero.4. What percentage of the risk is borne by the investor in a tax-advantaged account?a. The investor gets 100 percent of the returns and bears 100 percent of the risk.12. Bergstresser, D., Chalmers, J. M. R., & Tufano, P. (2009). Assessing the costs and benefits of brokers in the mutual fund industry.The Review of Financial Studies, 22(10), 4129-415613. Morey, M. (2003). Should you carry the load? a comprehensive analysis of load and no-load mutual fund out-of-sampleperformance. Journal of Banking & Finance, 27(7), 1245-1271.3.31