4/29/2023 0 Comments Mutual fund turnover rate![]() Whereas tax-adjusted returns and tax-cost ratios look at funds' tax efficiency in the past, a fund's potential capital gains exposure helps you gauge how big of a future tax bill you could possibly face. Just be careful to keep funds with high tax-cost ratios in nontaxable accounts such as 401(k)s and IRAs. On the flip side, many good funds pay out distributions, so you shouldn't necessarily avoid a fund just because it has a tax-cost ratio. It could have plenty of other things wrong with it, like poor management, a bad record, or high fees. That's not to say that you should buy a fund just because its tax-cost ratio is low or zero, however. A tax-cost ratio of zero means that the fund didn't pay out any taxable distributions for the period. The average tax-cost ratio for equity funds tends to fall between 1 and 1.2. Think of tax-cost ratio as you would an expense ratio: The lower it is, the easier a fund is on the wallet if you own it in a taxable account. lists the average three-, five-, and 10-year tax-cost ratio for each fund. Unlike tax-adjusted return, sales charges aren't considered in the tax-cost ratio. For example, if there's been a recent manager or strategy change that's affected the fund's trading pattern, the three-year tax-adjusted returns may be more instructive than the five- and 10-year numbers.Īnother useful metric is tax-cost ratio, which looks at how big of a bite taxes take out of a fund's annualized return. Although longer time periods are generally more meaningful when it comes to evaluating funds' performances and characteristics, in some cases it might be useful to look at the shorter time periods. provides tax-adjusted returns for the three-, five-, and 10-year periods. However, you'll want to be careful about funds with big gaps between their pretax and tax-adjusted returns. It's worth noting that a fund can have a good tax-adjusted return not because it's been tax-efficient but simply because it has a high pretax return. It works in the same way as the category rank for total returns: a ranking of 1 is most desirable and means that the fund's tax-adjusted return is at the top of the category, and 100 means it's at the bottom. Meanwhile, the category rank helps you see how a fund's tax-adjusted return stacks up against its peers. The tax-adjusted return also factors in sales charges that you pay from buying the fund, so you can get a sense of how much money you're losing to fees and taxes when comparing it with the pretax return. State and local taxes aren't included in the calculation because they vary across the country. Note that uses the highest federal tax rate when dealing with short-term capital gains and income (currently 35%) and the 15% rate for long-term capital gains. The tax-adjusted return accounts for a fund's capital gains, dividends, and interest during the period, but it doesn't include tax consequences from selling the fund in the future. One of the quickest ways to understand a fund's tax implications is to compare its pretax return with its tax-adjusted return. Pull up a fund on and click on the Tax tab on the navigation bar at the top of the page to get a glimpse of a fund's tax profile. That's not the only thing to look at, though. So, what's the best way to gauge how hard a fund will be hit by taxes? High turnover can be a signal that a fund might not be tax-efficient. (Read my colleague Russ Kinnel's take on the injustice of the mutual fund tax code here.) Like all investors, fund investors have to pay taxes on dividends from stocks and interest from bonds, and they also have to pay taxes on all fund distributions, including capital gains, which occur when a fund manager sells an underlying holding for more than its purchase price. Exchange-traded funds have also been quite tax-efficient over time.īut investors in conventional mutual funds can get stuck with a tax bill on their mutual fund holdings, even if they've lost money since they've held the fund. Stock investors pay taxes on an investment only if they have pocketed dividends or income or have sold the fund for a profit. Below we'll take a look at some basic metrics that will help you gauge how tax-friendly a fund is.įund investors are at a disadvantage when it comes to taxes. ![]() Whether you're just starting out or are a longtime investor looking to make changes to your portfolio, understanding a fund's tax efficiency can mean more money in your pocket in the long run. Tax frenzy may reach a fever pitch in April, but it's a mistake to only consider your tax bill around tax time.
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