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Assessing the Impact of Taxes on mutual funds

- Alan Lavine and Gail Liberman

Keep as much of your mutual fund investments in tax-deferred or tax-efficient investments. The reason: Taxes on fund returns are on the rise, according a research study "Taxes in the Mutual Fund Industry 2005" by Lipper Analytical Services, NY. Here is what the research firm found:

  • Over the last ten years taxable mutual fund investors have lost each year, on average, 20% to 38% of their load-adjusted returns to taxes.

  • Mutual fund capital gains distributions are once again on the rise!Coming off multi-year lows, short- and long-term capital gains increased 126% and 404%, respectively, in 2004. This means investors will pay more taxes on year end capital gains distributions.

    Lipper estimates that taxable mutual fund investors surrendered over $9.6 billion to the taxman in 2004--an increase of 48% from 2003.

    Tax burden continued its rampage on taxable fixed income funds. Taxes' drag on performance was two to three times that of the expense ratio.

    Good news! Over the last few years the impact of tax drag on equity funds has narrowed. Tax drag on equity fund performance has declined from being, on average, two times the expense ratio to being about 60% of the expense ratio in 2004.

    Comparing tax-managed funds to their non-tax-managed counterparts in four of Lipper's equity classifications, Lipper found tax-managed funds kept more of their pre-tax wealth and provided, in many cases, above-classification-average before- and after-tax returns.

    Tax managed funds use investment strategies to keep dividend and capital gain income to a minimum. The Vanguard Group has a stable of no-load tax managed mutual funds. You can purchase Eaton Vance's tax management funds from a broker.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).

    To read more columns, please visit the column archive.

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