Mutual Funds

There are many reasons why mutual funds have become a common investment vehicle: investors get the benefit of a professional fund manager making the investment decisions; mutual funds are a relatively inexpensive way to satisfy the need for diversification; and they don't discriminate against the small investor.

But, as easy as they make investing, deciding when to get in or out of a mutual fund is a bit more challenging. Mutual funds usually pay capital gain distributions in November or December. If you buy into a fund before the distribution date, you will be taxed on the gains that are distributed even though they have already been reflected in your purchase price. Consider waiting until January to buy into the fund.

Although you have no control over the timing of sales inside of a mutual fund, you can look for mutual funds that consider certain tax-saving strategies. Some funds trade actively, while others employ a buy-and-hold strategy. When comparing two funds with similar performance, consider the one with the lower turnover ratio. This fund will generally have fewer capital gain distributions. A high turnover ratio doesn't necessarily mean higher taxes, though.

To calculate exact gains or losses on mutual fund investments, save every statement. Determining which shares are sold can reduce your gain, or at least qualify it as long-term, which is subject to lower taxes. Also, consider everything that makes up your basis:

  • Fees or commissions paid when you bought the shares

  • Reinvested dividends for which you have been taxed

  • Nontaxable returns of capital

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    Delay late-year mutual fund investments until after the fund's dividend date.
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