The Tax Pitfalls of Mutual Fund Investing
Mutual Funds used to be the biggest show in town but with the innovations in the ETF Industry there are many reasons to avoid them: Lack of Communication, High/Hidden Costs, & Over-Diversification to name a few. One of the most compelling reasons come in the tax advantages that ETFs have over Mutual Fund Investing. Profits from Mutual Funds are subject to capital gains tax in non-retirement accounts and you as an investor are held accountable for the internal trading that the fund manager executes throughout the year. You have no control over when Mutual Funds distribute these capital gains to you which usually occur in the next couple of months. This can also be accelerated by other fellow shareholder’s selling the Mutual Fund, potentially increasing the capital gains tax you incur. This could even occur in a year where you don’t sell any Mutual Fund shares yourself or even when the fund incurs a loss.
In other words, you can lose money in Mutual Funds and still have to pay taxes…
The main difference is that capital gains distributions on ETFs are rare and usually only paid when the entire ETF is sold, not while you are holding the ETF. The taxes on any gains from the sales of these internal holdings are usually delayed until the entire ETF is sold, giving the investor more control over their tax situation. As with any investment, it’s important to know all the implications that are involved and if you own any Mutual Funds pay close attention to what taxable distributions they are adding to your situation over the coming months.
Read Fortune Magazine to find Sam G Huszczo CFA, CFP’s thoughts on the growth of the ETF industry in the first article below: