After Taxes

There’s one other factor in the mutual fund discussion: taxes.

I’m not talking about the debate in Washington over top marginal tax rates. I’ll leave that to the politicians. What investors need to worry about is capital gains. Active mutual funds buy and sell shares as they manage their holdings. This activity generates gains and losses, and our tax code requires that any realized gains need to be taxed. In order to avoid paying the taxes themselves, the mutual fund companies pass through the gains to their holders.

Funds held in a 401(k) or IRA aren’t affected. Any taxes are paid when the money is withdrawn. But funds not sheltered from taxes are likely to experience “tax inefficiency.” That’s where taxes have to be paid today even if the fund is never sold. It has the effect of raising the cost basis at the expense of negative cash flow. It’s a side effect of high turnover. Many index funds whose constituents tend not to change have less of a problem.

So many folks are drawn to index-based Exchange Traded Funds as their investment vehicle of choice. We use them too. They allow us to manage our taxes, manage our holdings, and own over 3000 stocks around the world in a tax-efficient manner.

Because when it comes to investments, taxes matter. It’s not what you make, it’s what you keep.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-05T20:27:38+00:00 September 23rd, 2010|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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