"Of Mutual Interest,"-Mutual Funds & Taxes
Tuesday, April 10, 2007SUSIE GHARIB: With tax day just a week away, many Americans are facing the tax consequences of their investment decisions. But when it comes to mutual fund investing, there are some ways to curb the tax bite. In tonight's segment "Of Mutual Interest," Erika Miller looks at tax-efficient investing strategies that could help ease your tax burden.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: As most investors know, mutual funds are required to pass along the income and realized profits in their portfolios to shareholders in the form of a capital gains distribution. So, if you invest in the fund through a taxable account, you will have to pay taxes on those gains. As Christopher Davis of Morningstar points out, this can take a huge bite out of your returns.
CHRISTOPHER DAVIS, FUND ANALYST, MORNINGSTAR: I've seen a lot of statistics that say that the average equity fund investor sacrifices around two percentage points a year of their returns to taxes. So, it's a pretty substantial hit. And over decades, that's going to add up to tens, if not hundreds of thousands of dollars, depending on how much you're investing.
MILLER: Tax-managed funds are designed to keep distributions to a minimum through a variety of strategies. Donald Peters, who manages three tax efficient funds for T. Rowe Price, keeps turnover low.
DONALD PETERS, PORTFOLIO MANGER, T. ROWE PRICE: The primary thing that we do is invest for the long-term. So, as an investor with a multi-year time horizon, we tend to trade much more, much less frequently than competitors who are focused on just pre-tax returns.
MILLER: But not all trading is discouraged. Tax-managed funds typically like to sell losing stocks.
PETERS: Loss recognition generally is very good because we can build up a tax shield or a loss carry forward that we can have offset any sort of gains that we would recognize.
MILLER: If you want to evaluate the tax bite of various funds, the Internet can help. For example, on Morningstar's website, you can pull up a fund's tax-cost ratio, the percentage of return that goes to the tax man. You can also find out its tax adjusted returns over a particular period. So what should you do if you have your heart set on a fund which typically carries a heavy tax load?
DAVIS: If you are going to invest in a fund that is not going to be tax efficient, try to keep it in something like an IRA or in your 401k.
MILLER: Tax-efficient investing can be an easy way to boost your investment returns, but experts say it shouldn't be the only criteria in picking a mutual fund. After all, some funds are tax efficient, because they lose money. Erika Miller, NIGHTLY BUSINESS REPORT, Short Hills, New Jersey.
