Investing in tax-managed funds
- By Milt x_Zall
- Mar 23, 2000
Investing in mutual funds that strive to keep their tax bite to a minimum
can put extra money in your pocket. Why? Because it's not what your fund
earns but what you keep that counts.
By law, mutual funds must distribute 95 percent of their realized gains,
and the tax bite from those distributions reduces the average fund's return
by 2.6 percent. That is a significant sum when you consider that the average
annual return for U.S. diversified mutual funds during the past 10 years
is 13.8 percent.
One solution is to invest in "tax-managed funds." Among this group, the
Schwab 1000 fund (SNXFX) is one of the most highly regarded. Another successful
tax-managed fund is the Vanguard Tax-Managed Growth and Income fund (VTGIX).
Both funds are tax-efficient and have outperformed the S&P 500 for the
past three years.
There are about two dozen funds that actively seek to minimize investors'
taxes. Portfolio managers employ several techniques to achieve this objective:
* They keep portfolio turnover low because selling shares that have appreciated
will generate taxable gains.
* They buy growth stocks that pay little or no dividends because dividends
are taxed as regular income.
* They practice "tax loss selling," which entails selling a stock that's
declined in value to offset realized gains from stocks already sold for
Advocates of tax-managed funds contend that managing tax liability is one
of the few variables investors can control. Most funds don't announce their
after-tax returns, only their pre-tax performance.
At times, the disparity between pre-tax returns and after tax returns can
be quite large. Of course, not all tax-managed funds are stellar performers,
so investing in them requires careful selection. You don't want to invest
in a tax-managed fund if it's after-tax returns lag its non-tax-managed
peers. For example, the Eaton Vance Tax-Managed Growth Gund (ETTGX), lagged
the S&P 500 by 5.58 percent in 1999.
Zall is a freelance writer based in Silver Spring, Md., who specializes
in taxes, investing and business issues. He is a certified internal auditor
and a registered investment adviser. He can be reached via e-mail at [email protected]
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