Taxes on losses
Unfortunately due to the laws regarding capital gains, it is likely that many people will be paying capital gains on holdings that have lost money this year. Mutual funds are taxed on each individual position rather than the fund as a whole, so even if you lost money with a fund you can still be taxed. This hurts when you’ve watched funds drop in the last two months of 2007 and the first 3 of 2008.
There is a way to get around these taxes and it doesn’t take any fuzzy math either. Tax-efficient mutual funds have sprung up in recent years that are built around the concept of letting winners run indefinitely and cutting losses whenever they can. Due to the way these funds operate, they don’t look nearly as attractive as traditional mutual funds, which post much better ROIs. In actuality these tax-efficient funds usually do the same if not better than traditional mutual funds after taxes are considered.
Tax-efficient mutual funds do not do any trickery or place dangerous trades. They operate just like any other fund but consider how fund will be affected if the sale goes through. Tax-efficient mutual funds also lower their transaction costs and trading fees by placing less trades. For this reason alone, absent the tax benefit, tax-efficient mutual funds appear to be a great way to protect your assets and maximize returns.
The pretax earnings of a mutual fund is what gets reported as the return, thus the public doesn’t know how great these tax-efficient accounts really are. For times like this, it’s a good idea to be tax-efficient to avoid paying hefty tax bills on losing positions.
