Mutual fund investors who hold their funds in a retirement account are not affected by this aspect, since income is tax-deferred in most cases. However, if you hold mutual funds in a taxable account, which includes a substantial portion of retirees, you will be doubly surprised this year. First, you will be hit with a tax bill whether or not you sold your fund during the year. To add insult to injury, you may be responsible for a large capital gains bill despite your fund being an overall loser for the year. Second -- and few people know about this one yet -- the expiration of three year tax loss carryforwards, means that your bill be larger this year than it's been in the last five. Why? The losses sustained during the bear market of 2000-2002 enabled funds to offset gains in subsequent years. That expires this year. Lipper estimates that the average capital gains distribution is going to increase 50 percent this year (see Boston Globe).
How Did We Get Here?
Whether you are an individual or an organization, the IRS wants its cut of any income from capital gains and dividends. Mutual funds are not excluded. So, when your mutual fund manager sells positions for what you hope is a gain, that gain is taxable, regardless of whether there are offsetting losses. The same is true when a stockholding pays a dividend. For organizations that pass through these gains to the shareholders, the gains are taxable at the individual's tax rate instead of the corporate tax rate. It is prudent to pass through these gains, since a large percentage of shareholdings are in non-taxable accounts, and few individuals that are in taxable accounts are in a higher bracket than the corporate rate.
You can't fault the funds for choosing to pass through the gains. However, you can fault them for high turnover in their portfolios. In 25 years, funds have gone from an average turnover of 8 years (meaning that fifteen percent of their holdings are bought and sold in a year) to today's average turnover of 100 percent. This means that in every year, all stocks are bought and sold. Some of the most egregious offenders turn over their portfolio five times in a year. The mutual fund industry has transitioned from buy-and-hold stewards of corporate America to being short-term, rent-a-stock traders in that time. Although evidence is unclear about why this has happened, the pessimist in me believes that it is because of soft dollar arrangements resulting in an incentive to trade frequently.
Why Should I Care?
High management and expense fees have already made it difficult to outperform their benchmarks consistently. Now, if you take into account that you will have to pay a larger bill to the tax man, that just means your performance suffers even more. If you lose one percent per year to taxes, that amounts to serious money over time. Over a 30 year saving period, this difference amounts to more than 25 percent of your ending net worth. Considering that this could make the difference between you running out of money before you die, it is not to be ignored.
What You Can Do About It
Index funds do not have high turnover. The only turnover they have is periodic rebalancing when their benchmark indexes change. This makes them more tax efficient.
An even better option is to engage First Sustainable to create a so-called Folio. This combines the technology available to a mutual fund to enable you to create your own diversified, asset-allocated mutual fund. You can buy fractional shares of individual stocks. This way, your only tax bill comes when you also do periodic rebalancing to suit your financial situation. To me, this is way more acceptable than swallowing a bill that was based on some conflicted manager's financial situation.
- Related Videos
- Related Articles
- Ask / Related Q&A
- Financing Investment Properties Easily With Cheap Property Loans
- How to Finance Investment Property?
- Resources of financing investments for elevation of the role of commercial and investment banks
- Why You Should Finance Investment Property Via Debt
- How To Finance Investment Property
- Finance Investments, Tips On Where To Invest
- Small Business Finance: Investment for your Business
- Personal Finance - Investing in your Futurew




Debt Services For Americans - Where to Locate the Most Respected Debt Relief Services
By: Matt Couch | 16/11/2009When faced with financial disaster and bankruptcy, most debtors feel helpless. Most people do not have any formal training for financial management. Hence they do not know how to manage their debts in a way which can avoid bankruptcy.
Help With Paying Bills - How Debt Settlements Will Provide Consumers Help With Bills
By: Matt Couch | 16/11/2009Most of the debtors today are delinquent on their accounts. They are behind their schedule in paying bills. All the consumers are facing challenge in making payment of the utility and other regular bills.
Debt Reduction Programs - How to Find Legitimate Debt Reduction Programs Online
By: Matt Couch | 16/11/2009If a debt reduction program is effective and successful, it is bound be legitimate. Good debt reduction programs work in two ways. First one is to reduce an individual's monthly minimum payments to assist him in keeping up with his other necessities.
Debt Settlement Online Application - How to Apply For the Top Debt Settlement Programs
By: Matt Couch | 16/11/2009Debt settlement programs are customized according to the customer's situation. The effectiveness can be determined by the customer's financial health by the end of the program. Generally citizens who are $10000 or more qualify for the settlement program.
Free Debt Relief Programs Online - Why to Always Compare Debt Relief Programs Online First
By: Matt Couch | 16/11/2009Let us go back to the time when you were a child. When offered an ice cream cone, the first thing that you would do is compare the cone you have got with the cones your friends and siblings got to satisfy yourself that you got the best deal. You compared ice cream cones when you were young. Today, you should compare debt relief programs for the same reason. The world is filled with unlimited settlement opportunities. The onus is upon you to find the best free debt relief option.
Debt Settlement Advice - Why Debt Settlements Are Increasing in Popularity For Americans
By: Matt Couch | 16/11/2009More and more Americans are opting for debt settlement for a simple reason-they do not have any other choice. The government cannot afford a scenario where thousands of individuals go bankrupt at the same point of time. When an individual goes bankrupt, the family, the employer, friends and relatives- all are equally affected.
Debt Settlement Services - What to Look For in a Online Debt Settlement Service
By: Matt Couch | 16/11/2009Why did the housing bubble burst? Why did people borrow money without having the ability to repay it on time? When interest rates increased, people were saddled with repayments that were greater than their monthly income.
Debt Settlement Tips Online - How Debt Settlements Work and Where to Find Help Online
By: Matt Couch | 16/11/2009Borrowers often wonder why credit card issuers and other unsecured lenders are providing a waiver on the original amount owed. They wonder why lenders are assisting borrowers to repay the loan.
Reasons to Fire Your Mutual Fund Company - Chasing Performance
By: Mark Brandon | 18/01/2006 | FinanceThis is the eighth article in a series of 10 devoted to showing how the mutual fund industry abuses the average investor. The whole series can be retrieved from http://sustainablelog.blogspot.com.
Reasons to Fire Your Mutual Fund Company - Tax Inefficiency
By: Mark Brandon | 15/01/2006 | FinanceThis is reason #8 in a 10-part series dedicated to showing how average investors are getting ripped off by the mutual fund industry. The whole series can be retrieved from http://sustainablelog.blogspot.com
Reasons to Fire Your Mutual Fund Company - Fresh out of High School
By: Mark Brandon | 15/01/2006 | FinanceThis is the 6th article in a series of 10 dedicated to showing how the mutual fund industry is abusing the average investor. The entire series can be obtained from http://sustainablelog.blogspot.com.
Reasons To Fire Your Mutual Fund Company: Soft Dollar Expenses
By: Mark Brandon | 14/01/2006 | FinanceThis is the 1st of 10 articles demonstrating how mutual funds are ripping off investors. The whole series can be downloaded from http://sustainablelog.blogspot.com.
Reasons to Fire Your Mutual Fund Company - Enablers of Poor Corporate Governance
By: Mark Brandon | 13/01/2006 | FinanceThis article is fifth in a series of 10 dedicated to showing how the mutual fund industry is abusing the average investor. The entire series can be retrieved from http://sustainablelog.blogspot.com.
Reasons to Fire Your Mutual Fund Company - Short Term Speculation
By: Mark Brandon | 13/01/2006 | FinanceThis the seventh article in a series of 10 dedicated to showing how the mutual fund industry is abusing the average investor. The entire series can be retrieved from http://sustainablelog.blogspot.com.
Reasons To Fire Your Mutual Fund Company: 12b-1 Fees
By: Mark Brandon | 11/01/2006 | FinanceThis is the 2nd of 10 articles from the Sustainable Log. The whole series can be downloaded from http://sustainablelog.blogspot.com.