Market Pulse: A ‘taxing’ problem for mutual funds |

Market Pulse: A ‘taxing’ problem for mutual funds

For a few reasons I prefer exchange-traded funds (ETFs) to mutual funds. Investors must agree as the growth rate in ETFs has surpassed the growth in mutual funds.

The month of December points out one of the flaws in mutual funds … they are not tax efficient.

For taxable accounts, it’s a bad idea to buy mutual funds in early December. That’s because most every mutual fund distributes a capital gains payment to its shareholders.

The shareholders need to claim those payments on their taxes, even if they only held the fund for a few days or have a capital loss on the investment.

Here’s why: Mutual fund managers constantly sell securities in order to meet redemptions or rebalance their assets. The capital gains from the sales are passed on to shareholders. In 2013, the gains may be substantial.

ETFs don’t have that problem. They meet redemptions with an “in kind” redemption of shares. ETFs are treated like stocks, so investors only have to pay capital gains taxes on securities that they’ve sold for a profit.

There are some cases where ETFs pass on capital gains, but they are rare. It can happen with some of the leveraged funds or inverse funds, but those funds are not good buy-and-hold investments anyways.

Tax efficiency is one of the reasons ETFs are preferred over mutual funds. A major reason is lower management fees. When you compare like securities, ETF fees are almost always lower than mutual funds.

Mutual fund companies also see this advantage, which is why traditional mutual fund companies like Fidelity and Vanguard are introducing more ETFs than they are mutual funds.

If you invest in a taxable account, consider twice before buying a mutual fund before it declares their December capital gains.

David Vomund is an Incline Village-based fee-only Registered Investment Adviser. Information is found at or by calling 775-832-8555. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.

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