Here comes the year-end fund tax bite

Ahh, the holiday season.  You’re relaxing with (or avoiding) your family, eating and drinking to your heart’s content, blissfully unaware of the outside world. Aunt Linda is re-telling the story of the blizzard of ’72 and your uncle Walt’s snores have driven everyone from the living room.

And yet somewhere between the last piece of pumpkin pie and popping the champagne cork on New Year’s Eve, your portfolio of mutual funds may have suffered a quiet but not insignificant hit.  You see, it has been an excellent year in the US stock market. As I write this, the S&P 500 has gained over 20% this year and small-cap US stocks have had even larger gains.

If you own low-cost and tax-efficient index funds and exchange traded funds, you’ve participated in this gain and you get to decide to realize this gain or simply hold your position and continue to defer the unrealized gain.

However, if you own actively managed mutual funds that have spent the year trading stocks in hopes of beating the market, you may not have that luxury.  Mutual funds are required by law to pass through any gains they have realized during the year.  So if a fund bought a stock in 2009 and sold it in January of 2013, and you bought the fund in February, you get to pay for a portion of the tax liability. The average mutual fund has annual turnover of  50-75% (depending on who’s counting and how).  This means that roughly one out of every two stocks in a fund is sold each year, and in a year like 2013 many of those stocks were sold at a gain.

After a four-and-change-year bull market like we’ve just seen, mutual funds have eaten up their loss carryforwards (they can capture losses just like you and me) and will be distributing more and more gains to investors.  Sometimes these are significant,and here’s a quick list of some funds that have already reported estimated distributions for 2013:

  • Janus Forty: 16% capital gain distribution
  • Janus Venture: 14% capital gain distribution
  • Columbia Acorn Select: 15% capital gain distribution
  • Longleaf Partners Small-Cap: 14% capital gain distribution
  • AllianceBerstein Equity Income Fund: 8% capital gain distribution
  • Growth Fund of America: 6-8% capital gain distribution

And my personal favorite:

  • DWS Small Cap Value Fund: 38.5% capital gain distribution (Are you kidding me?!)

Vanguard hasn’t released capital gain projections for 2013 yet, but here’s a list of distributions paid from Vanguard stock index funds for 2012:




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These taxable distributions mean that you’ll owe the IRS whether or not you sell your position in the investment.  Lipper estimates that equity mutual fund investors surrender 1% of their portfolio value to the IRS every year, a great deal of which is due to capital gain distributions.  Successful investing is about managing and minimizing the headwinds of costs and taxes that we all face in the markets. Investors would do well to avoid actively managed funds for a myriad of reasons, but reducing the IRS’s annual take is certainly high on the list.


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Mutual Fund Investors Get Clobbered with 2012 Tax Hit

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