When Should I Keep Financial Records for Mutual Funds?

By: Stephen L. Nelson, CPA

While you might assume any mutual fund investor should use Money's mutual fund
record-keeping tools, that isn't the case. Because investment record keeping,
including mutual fund record keeping, requires significant work and involves complex-
ity, you need to make sure the effort is worth it.
In general, you keep investment records for any of the following reasons:
&bull You want to track interest and dividend income.
&bull You want to track realized and unrealized capital gains and losses.
&bull You want to measure or grade the profitability of an investment by calculating its
annual return or yield.
Obviously, all three of the tasks in this list sound worthwhile, but many investors won't
need to use Money's record-keeping tools to get this sort of information.

Tracking Investment Income
If your investing is done using tax-deferred accounts, such as individual retirement
accounts, 401(k)s, and other similar investment containers, you don't need to track the
investment's income. The income from tax-deferred investments stored is not currently
taxable. The money you contribute to one of these tax-deferred accounts can be counted
as a deduction when the money is transferred into the account. Any money you
ultimately withdraw from one of these accounts can be counted as income when you
move money out of the account and into your regular checking account.
For example, if you contribute money to an individual retirement account by writing
a check on your regular bank account, you can categorize the check as "IRA contri-
bution" when you write the check. This categorization lets you easily track the IRA
contribution deduction you will need to report on your tax return. Similarly, if you
withdraw money from an IRA account, all you need to do is categorize the deposit as
IRA income. This lets you keep track of the IRA withdrawals you will also need to
report on your tax return.

Tracking Capital Gains
As mentioned earlier, realized and unrealized capital gains are often the second
reason for using Money for investment record keeping. In the case of a regular
taxable investment account, any time you buy and then later sell an investment, you
experience a capital gain or loss that needs to be reported on your tax return. Because
capital gains and losses are important for your tax return, when you keep records of
taxable investments you want to track these items. You even want to track potential,
or unrealized, capital gains and losses.
However, while tracking unrealized and realized capital gains and losses is important
for taxable investment accounts, you don't need to do this for tax-deferred investment
accounts like individual retirement accounts and 401(k) accounts. The reason is simple.
For tax-deferred investment accounts, gains and losses aren't taxable. Just as is the case
with investment income, inside a tax-deferred investment account, gains and losses
have no effect on taxable income. Again, the only tax effect comes from money you
move into and out of the account. In general, money you move into the account is a
deduction for purposes of calculating your taxable income. Money you move out of
your account is an income amount for purposes of calculating your income tax return.

NOTE The general rule described in the preceding paragraph-that money moved into
and out of a tax-deferred investment account is what produces a tax deduc-
tion or taxable income amount-is true. However, predictably, some tax-
deferred investment accounts don't work this way. There are, for example,
nondeductible IRAs. A nondeductible IRA doesn't give the taxpayer a deduc-
tion merely for moving money into the account. Also, a Roth IRA doesn't ac-
tually produce any taxable income just because you move money out of the
account. The primary benefit of a Roth IRA is that you get to withdraw money
from the IRA without including the withdrawal on your tax return. However,
in spite of the fact that money moved into or out of certain types of IRAs doesn't
trigger a tax deduction or taxable income, the general rules described here still
apply. Even for nondeductible IRAs or Roth IRAs, you don't need to track in-
vestment income, dividend income, capital gains, and capital losses for tax
record keeping using Money.

Measuring Investment Performance
As identified earlier, the third reason for investment record keeping concerns
investment performance measurement. In general, one of the things you want to do
when you become serious about your investing is calculate how good or how bad an
investment performs. Complete and accurate investment records force you to honestly
evaluate your investing.
One of the ways you measure investment performance is by calculating the annual
return, or yield, produced by the investment. For example, if you buy a stock for $12
a share and later sell it for $18 a share, you should calculate the annual return on the
An annual return, or yield, resembles an interest rate. By comparing the return a stock
earns to the return provided by other investments, you gain a frame of reference and
get a better idea of whether a particular investment makes sense.
While calculating returns obviously makes sense, note that one of the tasks your mutual
funds management company does is calculate annual returns. Therefore, you don't need
to duplicate this effort. In effect, one of the services you are already paying the
mutual funds management company for is the calculation of this important
performance measure.
NOTE Mutual fund management companies calculate returns on an annual basis-
typically using the calendar year as the period for which returns are calculated.
Your investment holding period may not match the period for which the return
was calculated. For example, if you hold an investment for one year but your
year runs from July 1 to June 30, a return measure provided by the mutual fund
company may not be useful if the return is from January 1 to December 31.
Nevertheless, if you use the prudent mutual fund investment strategy-which
is simply to invest for longer periods, to buy and then hold-the mutual fund
management company's performance measurements do give you the
information you need.


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