Study Highlights Tax Drain On Mutual Fund Performance

by Mike Godfrey, Tax-News.com, Washington

20 April 2004

A recent study has found that taxation, as well as expenses, has been taking a significant bite out of mutual fund returns in recent years.

The study conducted by Lipper Inc (a division of Reuters) found that last year, US fund investors paid an estimated $6.5 billion in tax, whilst registered investment companies distributed the second lowest amount of capital gains and dividends since 1995.

Lipper’s research also found that over the last ten years, taxation eroded up to 24% of equity mutual fund returns, and up to 45% of fixed income fund returns.

However, the study also found that over a five year period, expenses accounted for the largest chunk of mutual fund costs at 32%, compared to 24% taken in taxes. This was largely attributed to the bear market and loss accumulation to reduce capital gains tax payments.

Conversely, taxes were the biggest drain on fixed income fund returns over five years at 37% of average taxable gross returns, with expenses gobbling up 18% of fund performance.

With much more focus being applied to mutual fund expenses in the light of the recent investigation into mutual fund trading practices by New York's Attorney General Eliot Spitzer, the Lipper report concluded that fund bosses should pay more attention to managing tax losses in order to remain competitive.

Of the $3.47 trillion of assets in taxable accounts, only 16.8% was held in tax managed equity classes, the firm observed.

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