Where Smart Money Goes.®
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Where Smart Money Goes.® |
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Tax Management Many
funds are not tax efficient. What
is meant by tax efficiency? Suppose
a fund is 80% tax efficient. If the
fund earned an investor 10% before tax, the investor would yield 8% after tax.
Inefficient fund managers are primarily focused on portfolio yield and not
on tax loss harvesting, increasing holding periods, or reducing turnover rates,
All of which adversely
affect taxable investors. In 2000, a study was completed on 355 equity-oriented mutual funds with assets greater than $100 million [1]. The fund returns were compared to the Vanguard Index 500 over ten, fifteen, and twenty years. Of the 355 funds, after capital gains and dividend tax, 91%, 96% and 86% under-performed the Vanguard index 500 fund for the 10, 15 and 20 year periods, respectively. Table 1.1
It
is also important for investors to review their current holdings to look for
funds that are losing value and out of which investors are pulling money. It is possible for a fund to give one a negative return while at the same
time giving one taxable capital gains. A
2001 Congressional Joint Economic Committee report stated that out of 45 of the
largest stock and balanced funds, 60% posted negative returns for 2000 and 85%
of them also had capital gains distributions [3]. This happens in funds that are in decline where investors are
pulling their money out. In this
situation, the managers are forced to liquidate their unrealized gain positions
in order to fund the outgoing flow of money. Thus, it is good to study
current holdings to ascertain if they will
be liquidating unrealized gain positions to fund the cash outflow, and then
consider getting out before they serve up a negative return followed by taxable
gains. You can visit Morningstar's
website (www.morningstar.com) to find
out the size of your funds' unrealized capital gains. To
summarize, it is important to choose funds with a history of high tax efficiency
that offers low annual taxable distributions in a given asset class. DFA offers excellent tax-managed funds where the primary focus is to
maximize the after-tax value. These
funds harvest capital losses, minimize dividend yields, and avoid short-term
gains resulting in an extra 80-120 basis points of after-tax returns. Just as important, however, these funds deliver this performance without
compromising the exposure to the asset classes. They even offer tax-managed funds that target value and small cap market
segments. DFA reduces dividend
yields and minimizes taxable gains while still offering exposure to the economic
factors in the return. Works Cited 1.
Arnott, Robert D., Andrew L. Berkin, Jia Ye, ”How Well Have Taxable Investors
Been Served in the 1980’s and 1990’s?” Journal
of Portfolio Management Summer 2000 v26 i4 p84 2.
KPMG Peat Marwick LLP, “An Educational Analysis of Tax-Managed Mutual Funds
and the Taxable Investor." 3. Saxon, Jim, “The Taxation of Mutual Fund Investors: Performance, Saving and Investment” Congressional Joint Economic Committee report, April 2001, P9 Copyright © 2008 Karmikel Investments - ALL RIGHTS RESERVED
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Active vs. Structured Management Wealth Transfer, Legacy Planning & Charitable Giving
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