Taxes Take A Bite Out Of Funds

by 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-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.