| NEW YORK
NEW YORK Nov 16 In a volatile year for the
stock market like this one, it's worth paying attention to
mutual funds' potential tax situations before they make
distributions. If you buy into a fund with a hefty distribution
slated, you'll end up paying the price. Conversely, if you
invest in a fund with a lot of capital losses built up, you've
just found yourself a nice tax haven.
Investors often don't think much about distributions, but
at this time of year they should. By law, all mutual funds must
distribute any taxable gains realized during the year from
selling appreciated stocks. Most do so in December, before the
tax year ends.
Investors who buy into a fund just before its distribution
will owe tax on the entire payout, even if they held the fund
for just a few days.
"It is prudent for an investor to look at the distribution
schedule and try to see what it's posted historically. You may
want to work around some of those dates from a tax
perspective," says Brittney Saks, a personal financial services
partner at PricewaterhouseCoopersin Chicago.
What might funds' tax situations look like this year?
Vanguard and Longleaf have recently released numbers that look
pretty tame. For those that haven't released data yet, a good
place to start is the "potential capital gains exposure"
statistic on Morningstar. It quantifies a fund's gains or
losses that have not yet been distributed to shareholders or
taxed, as a percentage of assets, based on estimates of both
returns and assets. While it's an estimate, it's a pretty good
indicator of those future capital gains distributions,
especially when looked at in conjunction with the fund's
"It should be a fairly mild tax season barring a few
quirks," says Russ Kinnel, Morningstar's director of fund
research. "It's been a kind of unusual year because it's flat
year-to-date, but with a lot of drama in the market with the
August-September sell-off and the October rally. The numbers
will say something about how closely the funds were watching
their tax positions."
From a tax perspective, expect bargains in foreign-stock
funds, Kinnel says, (Europe, anyone?). But year-end investments
in small-cap, mid-cap and gold funds could be more tricky. The
impact of any tax hit will be less for funds with rising
assets, and greater for any that has seen outflows, because
there are less assets for any gains to be distributed
Those with relatively high potential capital gains exposure
by October 31, according to Morningstar's calculations, include
Baron Asset Retail , a mid-cap growth fund, T Rowe
Price New Horizons , a small-cap growth fund, and T
Rowe Price Media & Telecommunications .
Those that may be tax havens include Vanguard European
Stock Index , a tax-efficient fund for those with the
stomach for betting on Europe; Bogle Small Cap Growth , a small-cap growth fund; and Litman Gregory Masters
Value , which boasts an all-star manager lineup and
could be working tax-free for some time.
In some cases, the tax impact is enormous. Take that
Vanguard European Stock fund, where it's possible to see more
details about its tax situation because Vanguard discloses more
details than most fund companies do. It's got $19.33 per share
in realized capital losses (or nearly 38 percent of the fund's
net asset value) at the end of September, and $32.70 per share
(or 64 percent of NAV) in unrealized capital losses. That's the
silver lining of the ongoing debt debacle in Europe for those
with the stomach to play it.
Obviously you won't want to make investment decisions
solely based on taxes. How much difference these mutual-fund
tax issues make to you depends on your own tax situation.
If you've still got a large tax loss carryforward (from
taking capital losses throughout your portfolio since the 2008
financial crisis), then you may be able to offset any capital
gains distributions with those stockpiled losses. In that case,
the funds' tax situations are a nonissue. However, if your own
stockpile of tax loss carryforwards has dwindled, and you
haven't taken losses this year, it's worth paying attention to
these coming distributions when thinking about whether to buy
or sell a fund before year-end
The author is a Reuters contributor. The opinions expressed
are her own.