US Mutual Fund Taxes Are The Most Significant Cost

Mike Godfrey, Tax-News.com, New York

23 February 2001

At the end of last year, the average US mutual fund handed its shareholders around 9.19% in taxable distributions, according to a new report by the research firm Wiesenberger Thomson Financial (WTF). Ramy Shaalan, the senior fund analyst in charge of the study put the unusually high figure down to a combination of high gains by many funds in 1999, followed by a flurry of redemptions when the markets started falling in March 2000.

The redemption requests from panicky investors which poured in 'in droves', according to the report, meant that fund managers had to sell winning stocks in order to raise cash, and although many portfolios suffered losses throughout the year, the gains were already locked in by the earlier sales. As a result, many US investors were left facing a 'double whammy' of investment losses and taxable gains, and are older, wiser, poorer, and a great deal more tax-conscious in the year 2001.

The SEC recently issued a new requirement (due to take effect in October this year) which will oblige mutual funds to disclose after tax returns in their prospectuses and advertisements. However, this has raised the hackles of the industry group, the Investment Company Institute (ICI), as the requirement states that companies must publish after-tax returns using the highest tax bracket, in order to give investors an idea of the worst case scenario. 'I think the SEC was a little excessive in what they required' said Matthew Fink, president of the ICI, in a less shrill moment.

There are alternatives for tax-aware investors, however, and these come in many shapes and sizes, and include tax-managed mutual funds, Exchange Traded Funds (portfolios containing 'baskets' of shares that can be traded like stocks), and HOLDRs, among others. It is also worth inquiring as to the 'record date' of any mutual fund that you are interested in investing in. This is the date that determines who the shareholders of the fund are, and whether they are eligible to receive its distributions, which are an annual feature of mutual fund investing. If you are a shareholder of a fund on this date, then you will be subject to tax on the distribution, even if you've only owned the investment for a very short time. This is known as 'buying the distribution', and many experts advise holding off from purchasing the shares until after the fund's record date.

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