John Spence

New Survey Examines Investor Tax and Diversification Savvy

Boston-based Eaton Vance released a lengthy survey today that looks at, among other things, how knowledgeable investors are about taxes and the importance of a diversified portfolio.

Below are a few key results excerpted from the section of the survey on mutual fund taxes:

• Most (73%) investors say that taxes have an important effect on the returns they receive from their investments in stock mutual funds.
• Nearly four out of five (79%) investors say they carefully examine tax implications in the investment statements they receive from their mutual fund provider, broker or other financial advisor.
• More than one in four investors (27%) is completely unfamiliar with the term "tax efficiency" as applied to investments.
• Four in 10 investors (40%) are unable to cite any investments that offer high tax efficiency.
• More than four in 10 investors (42%) who use a broker or other financial advisor say that their advisor rarely or never discusses the tax implications of their investments with them.

"While taxpaying investors seem to have a good understanding of the importance of after-tax returns as a goal, they are still too often in the dark about how investment taxes work," said Duncan W. Richardson, chief equity investment officer of Eaton Vance Management. "Helping investors make intelligent tax choices is one of the best ways for financial advisors to add value for their clients."

Also, only 30% of investors are aware of the recently-adopted Securities & Exchange Commission rule that mandates after-tax performance disclosure by mutual funds. At the beginning of December, the SEC put a rule into effect that required mutual fund companies to include standardized after-tax returns in advertisements and sales literature that listed after-tax returns or claimed the fund was tax efficient. The rule was originally supposed to go into effect on October 1, 2001 but the SEC extended the compliance date to December 1, 2001. Effective February 15, 2002, mutual fund companies must disclose after-tax performance in the fund prospectus.

CBS MarketWatch mutual fund columnist Dr. Paul Farrell said the new rules should help investors understand the importance of mutual fund taxes, particularly over longer time periods.

"In advertisements, fund companies only tout funds that have outstanding quarterly pre-tax performance," said Dr. Farrell. "Data providers and fund companies need to place more emphasis on after-tax returns."

Eaton Vance also surveyed investors about their views on risk and diversification in the face of a troubled stock market in 2001, and found:

• Six in 10 investors (61%) say that because of recent developments in the stock market, they have less appetite for risk.
• Only one in four investors (25%) has ever redeemed or sold a mutual fund because of poor performance.
• Only 16% of investors have reallocated or increased their investments in bonds because of the recent volatility in the stock market.
• Only one in five investors has changed the amount he or she normally invests in mutual funds (21%) or individual stocks (19%).

The results above jibe with anecdotal evidence that most equity investors are standing pat despite a prolonged bull market and lowered expectations of future returns.

"Many investors are realizing that the stock market was riskier than they thought it was, but most have decided to stay the course," said Morningstar senior fund analyst Scott Cooley.

Investors also indicated that the down market has reduced their faith in index funds, which reinforces the notion that the relative outperformance of S&P 500 index funds in the 1990s drove interest in retail index funds. From the Eaton Vance survey:

• In 2002, nearly half of investors (45%) say that investments in index funds have become more risky over the past five years, an increase compared to 2001 (39%).
• By a nearly two to one margin, investors say that they are less likely (50%), not more likely (27%), to invest in index funds over the next couple of years.

Finally, Eaton Vance found that about 85% of investors don't even know what an exchange-traded fund is. If you fall into that category, check out this site's cutting edge ETFzone and ETF screener.