Looking for Tax Bombs and Bouquets in Your Mutual Fund
Know your fund's tax position before you buy.
There won't be many years like 2009. Fund investors earned returns in the range of 20% to 70% on equity and high-yield bond funds. Even better, most didn't have to pay capital gains taxes, either. Funds had big losses on the books from 2008 to offset realized gains in 2009, so they were able to avoid making distributions.
But if you're buying funds today, you ignore taxes at your own peril. A good chunk of those past losses have been worked off, and income tax rates are set to rise in 2011. You might get by for a year or two without being hit by capital gains, but stock funds are meant to be held for 10 to 20 years. If you're shortsighted about taxes, you could pay a price down the line. Each year, funds have to distribute any realized gains after subtracting past and current realized losses.
Here's the current tax situation for mutual funds: Morningstar estimates each fund's potential capital gains exposure by using a fund's annual report on its net gains and losses, adjusting them for appreciation or depreciation since then. It is expressed as a percentage of the fund's assets. You can find the figure on the Tax tab for each fund's page, and you can also screen on a certain PCGE level in the Premium Fund Screener. Not many funds have released their year-end 2009 statements, so we're still adjusting from 2008 numbers. The figures aren't likely to be exact but should be in the ballpark. Typically, a fund will distribute a sum that's smaller than its PCGE, but there have been exceptions.
Russel Kinnel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.