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Tax Efficient Mutual Fund Investing
The closer you examine the thousands of investment choices available to you, the more apparent the differences become. In the course of your research, you may find two investments that carry similar costs of ownership, and similar investment returns. However, the after tax return for these two investments may vary dramatically.
The focus of this article is to show you that mutual funds can be managed in both tax efficient, and not so tax efficient manners.
Here’s a real quick primer course. When you sell a stock (or a stock is sold within a mutual fund you own), a tax event is triggered. The consequence of this tax event will depend upon whether there is a profit or a loss realized, and how long the stock was owned. It is important to note that the difference between taxes owed on short-term capital gains (stocks held less than 12 months) and long-term capital gains (stocks held longer than 12 months) can be quite substantial. At the Federal level, long-term gains can be taxed at a maximum of 15%, while short-term gains can be taxed at a maximum of 35%.
As a result, when measuring tax efficiency of your mutual fund holdings, the key items become:
It is quite possible that two mutual funds using drastically different investment strategies could generate identical returns. However, an investment strategy that employs fewer transactions with a long average holding period will generally be much more tax efficient than an investment strategy that requires many transactions with a short average holding period.
This becomes important to you at tax time each year because it specifically defines how much of the return you’ve generated you get to keep.
This is an excerpt from our 9-page guide “Keeping More of What’s Yours Already”. If you’d like a complimentary hard copy of this booklet, send us an e-mail by clicking here. Just type “Keeping More” in the subject, leave your name and address, and we’ll promptly send you a copy .
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